Business as usual?

We will continue to pursue a policy of openness to foreign investment in energy, a strategic sector for Russia," President Putin told the International Economic Forum in 2012. But what does an open strategic sector look like in Russia? The only other examples of what the Russian government sees as strategic sectors are defense, state monopolies, and the media, none of which appear particularly open.

Investors only had to wait until the first quarter this year for an answer. In March, a deal signed by Rosneft reshaped the Russian oil industry and significantly bulked up Russia's top oil producer. Rosneft's acquisition of the BP joint venture TNK-BP, in exchange for BP gaining 20% of Rosneft's shares, effectively consolidated Russia's first and third largest oil producers. At $55 billion, it was the largest deal ever signed in Russia and as a consequence, Rosneft even knocked ExxonMobil off the podium for the world's largest oil producer with 4.6 million bpd production.

For BP this deal marked a new strategic partnership in Russia and presumably a fresh start after years of turbulent internal legal battles at TNK-BP. "We hope to help Rosneft to deliver synergies through its acquisition of TNK-BP and to grow production and reserves through brownfield, greenfield and unconventional opportunities as Rosneft strengthens its position among the world's leading global energy companies," said BP's Chief Executive Bob Dudley.

By granting a 20% stake in Rosneft to BP, the Russian government appeared to define openness in the strategic energy sector as a form of foreign ownership with state control. In a market already restricted in the number of major oil companies, the relevance of the state to oil industry stakeholders has now risen. Or has it? In the country, many argue that Rosneft is managed with sound business acumen and decisive modernity, and that the TNK-BP deal was just business as usual. Either way, Rosneft's growth into the undisputed oil-producing champion has begun to change the landscape of the Russian industry for oil and gas companies and service providers.

FOREIGN SPARRING PARTNERS

The Russian government believes that it needs investment of more than $280 billion to maintain oil production at the current level until 2020, and indeed, a number of high profile deals have shown that there is interest in investing in Russia. Rosneft has been leading the effort to attract foreign partners, signing a joint venture agreement in 2012 with Norway's Statoil for exploring frontier areas in the Sea of Okhotsky and the Barents Sea as well as another JV with Japan's Inpex for exploration off Russia's Pacific coast. The state giant also concluded a joint venture with China's CNPC for a USD5 billion Eastern Petrochemical venture. Andrey Goltsblat, managing partner of law firm Goltsblat BLP, confirms that Russia has become a primary market for many large global players, who have realized that the country offers more growth perspectives than many other markets.

Yet, according Fernando Martinez-Fresneda, Repsol's General Manager for Russia, investing in Russia is not a simple process. "Repsol brings in its global technology and international best practices gained in the 25 countries we operate in," he says. "However, companies in Russia operate in the way that they are accustomed to, and as a foreign company it is not easy to tell them that sometimes they have to change their approach in order to be more efficient."

It took time for the Spanish company to develop its business in Russia after acquiring a 10% holding in West Siberian fields. "We have been analyzing and screening the market for five years; some opportunities failed and others were considered too high risk," Martinez-Fresneda says. He believes that it was important to take the time to do this before Repsol concluded its joint venture with Alliance Oil, which included an agreement to take over Russian gas development company Eurotek.

In 2012, after 20 years in the Russian market, Wintershall concluded an asset swap with Gazprom in which the German company received a 25% stake in blocks IV and V of the Achimov formation. In return, Gazprom obtained shares in Wintershall's natural gas trading and storage business. Mario Mehren, a member of Wintershall's Board of Executive Directors, explains that Germany's largest crude oil and natural gas producer and Gazprom are starting to share expertise: "We are working on a project to bridge the way from the North Sea to the Barents Sea, which is interesting for both parties. Gazprom is interested in the development of shallow waters on the Russian continental shelf. This is exactly where in the North Sea our Dutch colleagues are incredibly experienced. In return, Wintershall will completely transfer the currently jointly operated natural gas trading and storage business to Gazprom."

Dimitry Bolotnik, General Manager Russia & CIS of Roxar, summed up the situation: "Companies entering Russia should approach the market with a long-term vision: be patient and do not expect quick profits. Roxar is today bearing fruits of agreements concluded five years ago. The right level of cooperation is important: Russian oil and gas companies are looking for long-term partners."

Paying Off in the LNG Run

Total has been present in Russia since 1989. Jacques de Boisséson, appointed General Director of Total E&P Russie last year, took time to discuss with Focus Reports Total's involvement in some of the country's flagship projects.

Could you outline Total's operations in Russia?

Total's roots in Russia are in the Kharyaga field, which is located inside the Arctic Circle. Total has been operating this field since 1999 under Russia's only Production Sharing Agreement (PSA) for an onshore project. Kharyaga was the first PSA project in Russia to become profitable for the state. The Kharyaga field consists of six reservoirs. Lukoil and their predecessors were producing at four out of six reservoirs and the two remaining reservoirs were left untouched as they were too challenging. These two reservoirs are the ones at which Total is now producing, because we have the right technology.

We have a longstanding relation with Novatek, Russia's second largest natural gas producer. Novatek has a tremendous track record and has allowed us to make rapid inroads into the Russian market. In return, we have helped them to shorten their learning curve in the international arena, in particular with relation to Yamal LNG, an international project by nature. In addition to Yamal LNG, we are partnering with Novatek for the development of the Termokarstovoye gas and condensate field, where production is scheduled to start in 2015.

In addition, we co-own [25%] Shtokman Development AG together with Gazprom [75%]: a joint venture established for financing, operation and design of Shtokman phase I. Production of the Shtokman gas condensate field will contribute significantly to our production in the future. This project is a pioneering LNG project in the Arctic as well as a major challenge worth confronting.

Where would you like to take the Russian affiliate within the coming three to five years?

By 2020, Total aims for Russia to become its number one production country, representing 15% of its global hydrocarbon production. These are ambitious targets, but I believe we have what it requires to achieve them.

This number is mainly based on the success of the current development in Kharyaga, on the future production in Termokarstovoye, on the launch of Yamal LNG, and most of all on the beneficial impact from Novatek's growth, in which we aim to increase our stake up to 19.4%.

We have to be the first in class in production, but also in safety, reliability, and ethics. Not only because we committed to it, also because it is the way to get further opportunities in the business. It is the condition for growth.

A NEW CONTENDER

Never let it be said that Russians don't have patience. Russia's largest independent gas producer, Novatek, has been waiting since 2009 for a decision from the Russian government on whether or not it would be allowed to export LNG produced at its Yamal gas fields. Together with Total, the company is investing $20 billion in the project, but up until now Novatek was barred from signing export contracts through a 2006 law granting Gazprom monopoly rights to all gas exports.

But the situation has changed. The Russian government has announced that LNG exports from independent companies would be allowed as of January 1, 2014, thereby ending Gazprom's monopoly. Novatek CEO Leonid Michelson has been busy working on a long-term supply contract with China National Petroleum Corp to begin supplying the Chinese market from the planned start-up of facilities in 2016.

However, Gazprom is not giving up the struggle for control without a fight. Gazprom CEO Alexei Miller has stated that he plans to take Gazprom's share of the global LNG market to 15%, from 5% today, focusing on the Asia-Pacific markets. Indeed on June 22 2013 Gazprom signed a memorandum of understanding with a consortium of Japanese companies for a venture called the Vladivostok-LNG project. The Russian LNG industry is beginning to heat up.

Creon Energy: Faster Gas Markets

Creon Energy, the only Russian advisory firm offering a full range of consulting services in upstream, midstream and downstream sectors, has grown to become the leading Russian advisory group in oil and gas, petrochemicals, chemicals and related industries in the countries of the former Soviet Union. The company has been looking into alternative forms of delivery for gas from the Russian market and one of Creon Energy's flagship achievements has been its participation in the LNG project in Vladivostok.

"In our era, in order to be competitive, companies need to be compact and mobile in order to move fast to markets with demand," says Dr. Fares Kilzie, Chairman of Creon Energy. He believes that mobility is the most important element for Russia's gas industry to maintain its global competitiveness.

Kilzie supports the idea of opening up the Russian export market to increased competition. "This is exactly the message that we are trying to deliver to the government ... the effect of free trade will be far better than having only one channel for the export of gas, which is Gazprom. Furthermore, any monopoly tends to become fat and lazy due to lack of competition. By having competitors in the market, companies run their businesses faster and with better efficiency."

REVISITING OLD TRAINING GROUNDS

Recently released estimates of Russia's total resources - previously restricted information - have confirmed EIA analysis that most of Russia's oil reserves are located in the part of Russia where the industry first started production, in West Siberia.

In June, Russia achieved a new post-Soviet record of 10.53 million bpd production, but the production growth was not thanks to Russia's legacy assets in West Siberia, but rather Rosneft's ramped up production in East Siberia. Rosneft has been focusing on its assets in the region like the giant Vankor field, in order to supply the thirsty Chinese market, which eventually expects one million bpd in oil supplies.

Russia's Blue and Black Belts

The prospect of LNG is not eliminating the huge demand for export pipeline infrastructure: not only are the Chinese pushing for an expansion of the oil pipeline network out of East Siberia, but Russia is still pressing ahead with the South Stream gas pipeline to Europe. Despite declining demand from Europe in the short term, long-term demand from Europe is set to increase.

But as Vitali Parizher, Director General of Tempobur, a company specializing in the horizontal drilling and construction of pipelines, explains the technical requirements for constructing these pipelines are increasing. He points out that there are about 80 companies in Russia that provide services of horizontal directional drilling (HDD) services, but that the majority of them do not possess equipment to construct crossings longer than 700m.

Tempobur has designed and built more than 600 HDD crossings under the most difficult geological and weather conditions including notable projects like Nord Stream, the Baltic Pipeline System, and the construction of the underwater pipeline under the Eastern Bosphorous strait towards Russia, a highlight for Parizher.

"The uniqueness of this project for global engineering practice is evident in the records it has set for horizontal drilling parameters," Parizher explains. "The transition pipeline is unprecedented in length and depth of burial, with some of the most difficult ground conditions ... the soil is unfavorable to the HDD method: crumbling rock and semi rock with interlayers of crushed stone, boulders and other large detrital rocks." For Parizher, this was a landmark project that expanded the envelope for horizontal drilling in the construction of challenging underground pipelines.

Russia's legacy assets in West Siberia, many of which Rosneft gained through the acquisition of TNK-BP, including fields like Samotlor and Priobskoye, are actually in decline. And the fact that a region with fewer resources is growing its production, while a region with more resources is in production decline, presents a long-term challenge to the industry.

Russia was once likened to a large storage tank with a tap that one could simply turn on and off: it was almost too easy to draw on Russia's seemingly inexhaustible oil reserves. In spite of the cold and the challenge of permafrost, many of the greenfields in Eastern Siberia can be developed according to similar production techniques. For Russia to generate long-term production growth, it needs to return to West Siberian fields, using new technologies to access more challenging reservoirs.

Some believe that the domestic industry lacks technologies to find productive areas in lower horizons and thus technological improvement is necessary not only in production but also in geology. Yet given Russia's substantial experience in onshore production, some Russian companies would strongly disagree with this picture of Russian technological capabilities.

For an example of homegrown success in tapping Russia's challenging legacy assets, one only has to look as far as Russian technology leader RITEK, a Lukoil subsidiary. The firm creates and develops modern high technologies to ensure the growth of reserves and production. In 20 years, RITEK has grown from a small enterprise into an oil company that produces more than 7 million tonnes a year, with more than 50% of its oil reserves located in hard-to-recover areas.

"I understood that true progress would be impossible without innovative development, particularly for an oil company with high aspirations," says Valery Graifer, Chairman of the Board of RITEK. "It was clear that the era of light oil is coming to an end and RITEK is placing its stakes on advanced innovations." Graifer, one of the founders of Lukoil, and also the company's Chairman, represents in many ways the lesser-known face of Russia: one that is both modern and innovative.

BETTER DRILLS

Oil production and the total depth of drilled wells have been continually increasing in Russia, generating great optimism for the country's drilling companies. Russia's largest oilfield drilling firm, Eurasia Drilling Co. (EDC) makes up about a third of the market and is operating in both West and East Siberia. EDC CEO Alexander Dzhaparidze recognizes the potential, stating that while this sector has historically been slow to invest in new technology – today 65% of Russia's rig fleet is more than 15 years old – upstream growth is pushing drilling contractors to upgrade their assets. EDC has invested more than $2.3 billion in the modernization of its fleet, and therefore, "our fleet is significantly younger than Russia's average," Dzhaparidze says.

Eriell became drilling market leader in Uzbekistan in 2007 before entering the Russian market in 2008. "Although we started our operations in Central Asia working with state-owned companies such as Uzbekneftegaz, 90% of our revenues came from our customers Lukoil and Gazprom who are represented in that market," explains Eriell Board Chairman Bakhtiyor Fazilov. "Our objective has been to enter the Russian market through our partnerships with Russian companies."

Fazilov goes on to explain his belief that the availability of a wide range of up-to-date drilling equipment is his company's competitive advantage in the Russian oil services market. "The program for modernization of the industry that has been implemented by the government is working in full force for our company," he explains. The company has won tenders against international companies such as KCA Deutag in Russia, which Fazilov believes is due to the 1,500 highly skilled engineers currently working for Eriell, in combination with the most modern equipment available.

TMK: Internationally Russian

"From the inception of the company," says Dmitry Pumpyansky, chairman of TMK, "we were aiming at developing an international business." This focus on creating a strong international corporate culture was one of the factors in launching the company's IPO on the London Stock Exchange in 2006, only five years after the creation of the company, according to Pumpyansky, and also one of the factors behind their successful acquisition of 10 pipe plants in the US in 2008 from IPSCO Tubulars Inc. Since then, TMK IPSCO has expanded to include one extra production site in the US, and one in Canada. Pumpyansky believes that expansion into the US via acquisition was the smartest option, as it gave TMK "an opportunity to enter the world's biggest oil and gas market as a domestic player."

Pumpyansky goes on to say that the company's move to the US was generally smooth, and today, the US and Russian technical teams work together as one integrated unit. However, the sales processes in Russia and the US do differ: while in Russia, TMK is used to dealing directly with the end users, which include Transneft, Gazprom, Lukoil and Rosneft, in the US, pipe is sold through distributors. "However," Pumpyansky clarifies, "we have seen similar market structure in other countries, so we adjusted quickly. The bottom line is: we are extremely pleased with our North American operations and colleagues."

TMK is in the global top three pipe producers today, but is valued at a 15% discount vs. top peer value, and a strategy to improve performance and profitability is being implemented across the company. With sales today in more than 80 countries, TMK has made the leap that few other large Russian companies have: successfully exporting their business to become a global scale player with operations around the world.

For drilling suppliers, the growth of the Russian market also represents an opportunity, but as Director General of the Association of Drilling Contractors Alexander Oganov explains, manufacturers of drilling equipment are facing increased price pressure from foreign competition, particularly from Chinese manufacturers.

The largest and the most advanced Russian manufacturer of roller cone bits and PDC bits is Volgaburmash. Historically, the company focused on producing in high volumes, delivering manufactured tools to oilfields in Western Siberia. However, over the past 10 years the company carried out large-scale modernization of its manufacturing plants and today, Volgaburmash is focused on technology differentiation instead of mass production.

In 2011, Volgaburmash established its own bit service department, creating a direct "manufacturer – customer" relationship with after-sales service. "With this tailored approach to production, we decided not to concentrate our efforts exclusively on sales," says Volgaburmash General Director Alexander Bosnak. "For us, provision of engineering support services for well construction was just as important."

ROCKY IN THE EAST

A significant share of new production in Russia is expected to come from East Siberia, with some analysts estimating undiscovered reserves of over 80 billion boe. These East Siberian deposits lie in an area that covers approximately 3.3 million km2 and to find them requires a major geological initiative.

However, for a few years, Russia's geological exploration sector has been in decline and unable to handle such demands. In 2011, the Russian government took steps to deal with this issue: to stimulate new efforts in seismic surveys, the government decided to establish Rusgeology, a holding company that incorporated 38 geological companies from 30 different regions of the country. The intention was that the enhanced financial and operational resources and coordinated planning could provide greater synergies in unlocking Russian hydrocarbon resources. Rusgeology's acting CEO Andrey Tretyakov explains that the company was established in order to carry out subsoil geological studies and ensure recovery of mineral resources using state-of-the-art geological, geophysical and geochemical techniques. "We are striving to create the country's largest, highly efficient, world-class geological business that will match the national interests of the Russian Federation. Our mission is to ensure sustainable growth and renewal of Russia's mineral resource base through new territories and new geological sites." Tretyakov continues.

Russia's Construction Visionaries

The construction industry remains one of the key catalysts of economic growth in Russia. The market is expected to grow by 9% in 2013. Naturally this attracts foreign construction companies that are ready to set foot in the country. Joint Ventures could be mutually beneficial in terms of receiving the best Western competences and in return providing them access to the Russian market.

According to Mikhail Polonskiy, President of Promstroi Group, a Russian EPC group, foreign companies find it difficult to enter the Russian market. Construction in Russia remains carried out in a traditional way. One of the main problems in the industry is the absence of demand for efficiency. "It is common that the process of investment planning and management is conducted by separate contracts for engineering, procurement and construction. In our opinion, in the near future a number of projects performed by EPC contractors will increase, which means that the niche for Western companies will also increase. If one has risk appetite, there is a good deal of work outstanding in Russia", he says.

One of fastest growing construction companies in Russia, RuzGazEngineering, is celebrating its 10th anniversary this year. The company has recently discussed a proposal with the Minister of Energy, Alexander Novak, to create a scientific base and trial centre in order to test Russian and international technologies. This centre will function as an incentive for smaller companies in the industry to develop and test their technologies. "Generally, it is only large state companies that can afford and have the ambition to develop this amount of engineering patents, and not the smaller private companies, which makes us unique" Ilshat Valiullin, President of RusGazEngineering Group of Companies says.

Another personality is Dr. Ivan I. Mazur, president of RAO Rosneftegazstroy (RNGS), a leading Russian construction company. Mazur has been working in the oil and gas sector for more than 30 years and is the founder of a new scientific branch called "engineering ecology". With more than 200 publications, and 18 patents, Mazur is leading the way for Russian environmentally friendly oil and gas construction projects. In addition to RNGS's domestic activities, the company has a strong focus towards internationalization. Currently international projects account for 30% of RNGS's activities. The CIS, the Middle East and Africa are priority markets for the company's activities.

One of the largest independent oil and condensate producers in Eastern Siberia is Irkutsk Oil Co. (INK), which has an impressive exploration track record throughout its 13-year history. In a period of four years, INK has discovered and contoured seven new fields. The company has recently signed an agreement with Rusgeology to create and adopt new technologies in exploration and production in East Siberia.

Today, INK holds 19 subsoil licenses and aims to increase its pumping capacity to 3 million tonnes of oil per year by the end of 2013, now they are connected to the East Siberia – Pacific Ocean (ESPO) oil pipeline. The two companies plan to jointly develop and apply techniques for assessment of the existing fields as well as new prospective blocks in the region.

INK has also contracted Halliburton to optimize its drilling processes by helping to minimize well positioning errors, as well as optimizing their layout and the number of production and injection wells. "East Siberia offers great opportunities," says INK CEO Marina Sedykh. "The region is expected to be the main source of Russia's production growth over the next 10 years."

Business as usual?

So, should we consider that it is just 'business as usual' in Russia today? Things are certainly starting to change in terms of the big international players looking increasingly comfortable operating with Russian partners. But for many of the cogs in the machine of the Russian oil and gas industry, the landscape looks remarkably similar to 20 years ago: huge reserves are still to be exploited in Western Siberia, and more adventurous projects like offshore Arctic exploration still seem a long way away. According to Gennady Shmal, President of the Union of Oil and Gas Producers, there is no rush to explore Arctic fields. The country has sufficient onshore reserves. As president of Rosneft Igor Sechin puts it, "the challenge of moving to the Arctic offshore is more ambitious than man's first walk in space or sending a man to the moon." What is certain is that it is a matter of when, not if. In the meantime, Russia simply remains the largest hydrocardon producer in the world.

EDITOR'S NOTE: Since the interview was conducted, Andrey Tretyakov was replaced by Roman Panov as CEO of Rusgeology.