U.S.S.R. E&P WOES CREATE OPPORTUNITIES FOR SERVICE FIRMS

Etienne H. Deffarges, Robert C. Moeller, John Elting Treat
Booz, Allen & Hamilton
San Francisco

Many oil field service and supply (OFSS) firms now have the opportunity to enter the Soviet Union.

Their technology can help reverse production declines in existing fields and improve long-term prospects for newly discovered reserves.

The Soviet Union is in the throes of it third oil crisis in 15 years. The U.S.S.R.'s first oil crisis was triggered by the unexpected decline of production from the Volga fields in 1977. Its second crisis was set off when West Siberian production faltered in 19851988, combined with a fall in oil prices which reduced the hard currency earnings needed to pay for imports of Western technology.

In the past, rapid shifts of internal investment funds into the oil sector and selected imports of critical Western oil field technology saved the day. Today, the situation requires a fundamental change because only a massive influx of Western capital, experience, services, and technology offers any hope of reversing the latest decline in Soviet oil production, which began in 1988.

At the same time, the world is going through its third oil crisis in roughly the same time period. Following a period of stable oil prices in the 1980s, the 1990s have opened with prices moving up by 50% in August because of the invasion of Kuwait by Iraq and the potential threat to Saudi Arabia's oil fields.

The combination of major energy producers such as the U.S. and U.S.S.R. facing steadily declining production and oil supply disruptions from the Middle East creates an even greater requirement to slow the decline of Soviet oil production.

The Soviet Union is the world's largest energy producer and the second largest consumer (Fig. 1), but problems have been piling up recently in the coal (miners' strikes), nuclear (Chernobyl) and, above all, in the oil sectors.

Even with the assistance of Western oil and oil field service companies, the challenges faced by the Soviet Union to stimulate oil and gas production are formidable due to several factors which include:

• Very low drilling productivity

• Accelerated decline of major basins due to exploitation methods favoring the first 2-3 years of production at the expense of cumulative output over the life of the basins.

• Rapid growth in marginal costs of production

• Difficulty in operating in increasingly hostile environments

• Limited investment resources available

• Growing environmental concerns

• Increased transportation/distribution costs as production steadily moves further away from major population centers with the production decline of Central Asia and Volga-Urals basins.

As a result, oil production has steadily fallen since 1988, and not even expected increases in gas production will be fast enough to offset the decline in liquids production. Moreover, this threat to future petroleum production comes at a time when the country's need for hard currency imports is rising, competition for scarce investment capital by consumer goods industries is mounting, and the future of the previously ambitious Soviet nuclear program is still faltering under Chernobyl's cloud.

There is a great need for new technology and investment to increase oil and gas production as well as to repair and construct pipelines. The Soviet Union has vast resources in hostile environments where marginal production costs are high.

Given the obsolescence and poor effectiveness of many technologies used by Soviet oilmen, these reserves could become economical if the technological challenges (offshore capacity, drilling in permafrost, enhanced recovery, etc.) are met with the help of Western companies.

The oil and gas production problems create corresponding opportunities for oil field services in the U.S.S.R. But a number of practical considerations have to be made by OFSS companies to succeed in implementing joint ventures with U.S.S.R. entities.

Joint ventures may be the only way to enter Soviet markets today because of socialist business attitudes and market characteristics that still prevail despite the recent dramatic political changes.

EXISTING PROBLEMS

Oil has always played a very important role in the Soviet economy, with the U.S.S.R. being the world's leading producer since 1974. More recently, with oil production declining, gas fields have become the main source of energy for domestic consumption, but gas production may also enter a more uncertain phase within the next few years.

The decline in oil production does not come from a lack of investment opportunities. In 1990, on oil and gas production, the U.S.S.R. is expected to spend over 20 billion rubles (about $3.2 billion to $12.5 billion, depending on the exchange rate used). The official exchange rate is US $1 = 1.60 rubles. The unofficial rate is U.S. $1 - 6.25 rubles.

The 1990 expenditures are up from 15 billion rubles in 1985 and 10 billion rubles in 1980. Total investment in oil and gas could represent about 10% of all investments in the country's economy between now and 2005.

What is behind oil and gas production problems in the U.S.S.R.? We see four major reasons for poor recent performance:

• Extremely low drilling productivity.

• Production methods favoring short-term output over the life-long production of reservoirs.

• Acute shortage of modern equipment, materials, and infrastructure for the industry.

• Many unresolved social and ecological problems. Without going into detail, the problems include ethnic conflicts/civil unrest in Azerbaijan and Kazakhstan, regional demands for autonomous control of hard currency revenues earned by oil and gas production, and environmental problems everywhere that continue to frustrate the meeting of production goals.

The Soviet drilling productivity problems are not recent. In 1977, the U.S. CIA estimated that the Soviet Ministry of the Oil Industry drilled a total of about 170 million ft between 1971 and 1975, with about 1,600 active rigs (21,250 ft/rig-year). In 1975 alone, the U.S. drilled 174 million ft with about 1,700 rigs (102,530 ft/rig-year).

Today, Baker Hughes estimates that 2,620 rigs are active in the U.S.S.R., and that total drilling footage for 1990 should amount to 166 million ft (63,360 ft/rig-year)-a significant jump in productivity. However, comparative figures for the U.S., with an average of 869 rigs active in 1989, showed 131 million ft drilled (150,850 ft/rig-year), more than double the U.S.S.R. productivity.

The poor Soviet drilling productivity, apart from massive overstaffing (the Ministry of Geology alone employs over 1 million people) comes mostly from the use of turbo-drilling rigs which are highly inefficient for deep drilling or for use in soft formations.

Soviet turbo drills worked reasonably well in the Urals-Volga region fields where oilbearing rock formations are hard and relatively shallow (6,000-7,000 ft). But the downhole turbines used by Soviet turbo-drill rigs have a relatively short life, typically 600 hr.

In addition, for turbo-drilling the high rates of bit rotation required to increase the rate of penetration cause a dramatic shortening of bit life, compared to rotary drilling. In the deeper, softer formations found in most new basins since the early 1970s, turbo-drills are therefore wholly inadequate.

Yet the proportion of rotary drilling rigs in use has changed relatively little since the mid-1970s; 80% of active rigs were turbo-drills then, vs. 67% today.

The main reason for using turbo-drills is that rotary drilling requires large volumes of high-strength steel pipe, which the Soviets seem unable to produce in large quantities. With turbo-drills, one can use fairly poor-quality drill pipe. Two other reasons for poor drilling productivity in the U.S.S.R. are the inferior quality of drill bits produced locally (or in Romania, which manufactures about 50% of the oil field equipment used in the U.S.S.R.), and the low performance of the most commonly used drilling muds and fluids.

Soviet production techniques emphasize maximum production over the early life-first 1-3 years at most-of hydrocarbon reservoirs. Often this is a detriment to maximum oil recovery.

Waterflooding has been used from the beginning of production in most Caspian Sea, Urals-Volga, and more recently West Siberian fields. Water injection allows the Soviets to minimize their oil field investment and to obtain a much higher initial level of production per well than would be possible under traditional Western production methods.

This means that, at least initially, the Soviets need fewer producing wells to achieve a given level of output-an important factor given poor drilling productivity and the always overambitious output levels dictated by their national 5-year plans.

But in some reservoirs large volumes of water, injected at high pressures, can channel and reduce the total amount of oil eventually recovered.

In many Central Asian and Urals-Volga fields, water cuts are now as high as 85%, with the average in those mature regions estimated to be well above 60%. These substantial rises in water cuts, after only a few years of high production, require a massive use of high-capacity pumps to increase fluid flow and maintain oil output.

Because of the large number of high-capacity pumps required, the U.S.S.R. cannot produce enough centrifugal high-capacity submersible pumps and has to import many units from U.S. firms. (Reda is the leading U.S. supplier of pumps).

However, even when high-volume pumps are used, water eventually breaks through to the producing wells, much oil is bypassed, and the water cut of the fluid produced from the original network of development wells becomes excessive. The field then has to be redrilled.

Infill drilling is common in mature Soviet oil fields, with increasingly smaller spacing patterns used for each successive development stage. The original spacing is 125 acres vs. 40 in the U.S. With infill wells, the spacing is reduced to 62, 30, and 15 acres.

This production doom-loop-waterflooding causes early depletion of reservoirs that in turn creates additional pressure to waterflood new reservoirs to compensate for decreasing production in mature fields and maintain production levels-is made worse by an acute shortage of modern equipment throughout the E&P stage.

Exploration efforts are handicapped by the shortage of high-quality seismic and well-logging equipment. Seismic recording and well logs use analog technology that has been obsolete in the rest of the world since the late 1960s. Good-quality geophones, cables, and downhole sensors are all in short supply.

This obsolete equipment leads to difficulties in identifying oil and gas-bearing formations. Soviet seismic refraction studies can only identify large-amplitude structures and lack resolution to identify smaller deposits. Mapping complex structural and stratigraphic traps lacks precision

Similarly, beyond drilling, production efforts suffer from poor-quality casing, tubing, packers, valves, etc. This is particularly problematic in gas well completions, where specifications on the hardware used are much more stringent.

In summary, poor production performance requires Soviet geoscientists to always look farther for new basins, drilling in ever more hostile environments, while production from traditional basins (Central Asia, Volga-Urals) declines precipitously (Fig. 2). And very soon, for each new basin (yesterday West Siberia, tomorrow the Arctic Circle or East Siberia?), the problems repeat themselves.

So far, oil production has been the most affected, but Central Asian natural gas production, which only became significant in the mid-1970s, is already declining as well (Fig. 3). How can this stop? Possibly through the help of Western-based major oil and OFSS firms.

OPPORTUNITIES

Given the magnitude of Soviet reserves and the size of yet to be thoroughly explored areas (e.g., East Siberia), the most pressing concern at the Ministry of Geology is how to improve development of existing fields and possibly reverse production declines in the more mature basins.

Hence, the recent deals announced with several firms, including:

• Canada's Fracmaster (which Shell recently bought into) to stimulate up to 1,000 wells in West Siberia

• Elf Aquitaine agreement to explore and produce 40,000 sq km of territory in the northwestern part of the pre-Caspian depression near the Volga River

• Chevron E&P exploration protocols in an area of 23,000 sq km which includes the pre-Caspian Tengiz field.

These agreements are likely to lead to a renewal of exploitation methods in these areas rather than to major exploration finds. Similar ventures being studied with C.F.P. Total (objective is to raise recovery rates for the Romashkiro oil field in the Tatar republic, using advanced tertiary recovery techniques), Kuwait Foreign Petroleum Exploration Co. (oil fields in the Gorky area), Texaco (Caspian basin), Amoco, Royal Dutch Shell, and other oil and gas majors focus on development and enhanced recovery of existing Soviet oil fields.

Nobody expects these majors to willingly use local oil field services and equipment. Whenever possible, they will use foreign OFSS firms, thereby increasing the penetration of Western-based OFSS companies into Soviet oil field markets.

Currently several U.S.based OFSS firms (Halliburton, Professional Geophysics Inc., Triton Engineering, and others) are active in the Soviet Union. Japan, West Germany and, to a smaller extent, Czechoslovakia, France, and Italy are exporting large amounts of large-diameter welded steel pipe (about 5 million tons-equivalent to 2 billion rubles-per year since 1985).

To determine which oil field market segments could best benefit from U.S.S.R. production problems, we developed the need and competition framework shown in Fig. 4. It suggests that the most attractive opportunities (upper right) are those in completion and production-oriented services, where Soviet technology is particularly deficient and where penetration by foreign firms has been little or nonexistent thus far.

COMPLETION SERVICES

Completion services (perforating and testing) and production services/reservoir engineering are two segments holding great promise for OFSS companies. Local hardware is deficient due to poor steel quality and lack of capital manufacturing know-how.

Reservoir engineering is limited and major Western-based competitors in this area have yet to enter the market. Technology/service transfer in these segments could stimulate the beginning of recovery of Soviet oil production.

In the U.S., Halliburton has the largest share of the completion services market, with its Otis subsidiary very strong in hardware.

Overseas, Dowell Schlumberger and Flopetrol (another Schlumberger subsidiary) are strong competitors very close to the Halliburton companies.

Other competitors in this area of the industry are Baker Hughes, Camco, Cameron Iron Works, and Dresser.

GAS WELLS

The recent emphasis on gas field development in the U.S.S.R. puts such things as specialized sulfur equipment specs at a premium. The above-named firms (all manufacturers of hardware) and more specialized firms such as Bowen Tools (high pressure/hostile environment equipment) may benefit from the Soviets' need for this equipment.

In the production services segment, most of the same OFSS firms compete, with specialized software firms filling specific niches in reservoir engineering.

DRILLING

The poor productivity of Soviet drilling efforts signals a clear need for service/equipment imports. Even though several companies are already exporting drilling bits to the U.S.S.R., other key components of drilling productivity, such as muds, and directional and turnkey services so far have not been aggressively marketed by foreign firms.

Notable exceptions are Houston-based Triton Engineering Co., which is currently negotiating the sale of turnkey drilling services, and Parker Drilling, which has signed a letter of intent to drill a 23,000-ft well.

MWD AND WIRE LINE

As mentioned earlier, Soviet wire line services still use analog equipment, while digital logging units have been the norm in the Western world since the mid-1970s.

There is also little or no mention of MWD (measurement-while-drilling) services being used, even in offshore areas where they have high worldwide penetration. The time may be ripe for selling comprehensive formation evaluation services (both MWD and wire line).

Halliburton Logging Services has made an early move to convert a Soviet manufacturing plant into a logging equipment plant. And one cannot forget about Schlumberger (over 65% of the wire line market worldwide) or Western-Atlas, the third major wire line competitor, as additional possible technology/service providers.

Other OFSS segments listed in Fig. 4 are less attractive due either to less interest (limited need) by the Soviets or already crowded with foreign companies (very competitive) such as seismic/geophysical services.

In summary, most larger OFSS companies with revenues of $250 million-plus and an involvement in the key segments mentioned above should be able to capitalize on the emerging business opportunities in the U.S.S.R.

Can these market opportunities be quantified at this early stage? Not really, since market and financial data coming out of the Soviet Union are still very sparse. Nevertheless, we can point to a series of key activity indicators which may help industry participants size the overall potential of this opportunity (Table 1).

It is difficult to assess what potential import levels in the U.S.S.R. might be. All in all, annual Soviet orders of Western oil and gas equipment do not yet reach the $1 billion mark.

In the 1970s, much-needed imports of high-capacity pumps were limited to about 30 units/month because of back orders and long lead times. The Soviets could have easily absorbed 100 units/month.

In oil-country tubular goods, the Soviets import about 5 million tons of steel pipe per year, representing about 30% of domestic requirements (40% in 1985). Similarly, the U.S.S.R. imports about 15% of its oil-grade pipe (casing, drill pipe, and pump tubing) requirements (25% in 1985).

Significant increases in imported products and additional services to turn around such a vital industry cannot be ruled out.

When they were building the pipeline network to transport natural gas from Western Siberia to Europe, the Soviets massively increased imports of pipeline equipment.

Without these imports, the rapid growth of Soviet gas production would not have been possible.

Similarly, maintaining oil and gas production at today's level may not be possible without a new surge in imports of services and equipment from the West.

SUCCESS FACTORS

In some cases, OFSS firms will be able to sell their services and technologies and receive payment in hard currencies. This will be particularly the case when the purchaser is a Western company that has itself established a joint venture in the Soviet Union.

In many cases, payment in kind (most likely in crude oil or refined products) may be off e red.

However, to fully exploit the market potential offered by the opening of Soviet OFSS markets, Western companies should consider entering joint ventures with Soviet firms.

Although over 1,300 joint ventures have been signed in the Soviet Union, fewer than 20% are operational due to various problems with bureaucratic delays, restriction on currency convertibility, lack of legal framework, and deficiencies in infrastructure such as transportation and communication (Table 2).

While these obstacles can appear formidable, they are not insurmountable.

BUSINESS DEFICIENCIES

Soviet business is characterized by over-staffing, perverse incentives, and slow decision-making.

Even the legal basis for business contracts is in its infancy.

Pricing decisions have traditionally been made with no regard to the balance of supply and demand. Support services (communications and travel arrangements, for example) fall far short of Western standards.

Computers, copiers, and fax machines are a relative rarity. Even adequate office space is scarce. Western businessmen must learn to tolerate and overcome these frustrations.

CURRENCY CONVERTIBILITY

Currency conversion is always a problem in a country with an inconvertible currency, but to the extent that the Soviets view an OFSS joint venture as increasing oil exports, they are likely to be flexible in funding solutions.

REGULATORY APPROVALS

Running the bureaucratic obstacle in Moscow and the regional capitals can be a trying experience.

The task is further complicated by the ongoing constitutional struggle in which the various Republics are trying to wrest control of critical matters away from Moscow's grasp.

In some areas, particularly the Baltics, the very issue of sovereignty is at stake.

MANAGING GROWTH

Developing the necessary sources of supply and logistics is a continuing challenge, and cannot be dealt with on a short timetable.

Joint ventures should set modest, achievable goals in their early phases.

Joint ventures must be built on mutual trust. This trust will grow most certainly if the objectives and the operational structure of a joint venture are clearly spelled out at the outset.

Three ground rules to be observed include:

1. Openly inform each other of any difficulties.

2. Devote best efforts to developing alternative solutions to compliance difficulties.

3. The joint venture's goal is profitability (not full employment or quantitative output).

   Finally, hope for the best but plan for the worst.

REGIONAL GOVERNMENTS

It is increasingly clear that successful joint ventures will be concluded with regional governments or industrial associations/cooperatives rather than with the central government in Moscow. This is probably good news, because there is less bureaucracy and greater motivation at the regional and local levels.

In the future, Moscow's role in joint ventures will likely be more of a rubber stamp. However, the need to work with a variety of state organizations on logistics will be a continuing challenge to western firms.

EXISTING FIELDS

The Chinese ideogram for "crisis" also signifies "opportunity on the wind." This is certainly the case for both the emerging oil crisis and OFSS firms looking at the Soviet Union today.

The obstacles are large but the opportunities far greater.

Given the Soviet situation, the best opportunities would appear to be in the areas of completion and production-oriented services, both in services and equipment.

In other words, the Soviets need more help from foreign OFSS firms in producing existing fields than in discovering new ones.

Many very large discoveries that need careful production management already exist.

ACKNOWLEDGMENT

The authors acknowledge the significant contributions of Ravi Bhaskaran, also from Booz, Allen & Hamilton, San Francisco.

Copyright 1990 Oil & Gas Journal. All Rights Reserved.