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Integra brochure
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January 18, 2006

A Few Oil Service Companies to Remain in Russia

It has been reported this week that the independent oil service company Integra has acquired the controlling block of shares  (50.6%) of OAO Tyumenneftegeofisika, a major exploration company. The company’s new owners intend to replace the current board of directors.  Besides, it is rumored in the market that Schlumberger, a large international service company, plans a merger with another geophysical company  -  Tymmenpromgeophysica. Experts say that the process of the domestic oil service market consolidation will not stop at that. Integra president Felix Lyubashevsky forecasts that in a some years only a few strong oil service companies will remain in Russia. He spoke about this and other oil service market trends in an interview to Dmitry Koptyubenko, RBC daily.
- Founded about a year ago, your company has made several big acquisitions. What is the source to finance the expansion?
- Initially, the basic shareholders’ money was used to set up the company. These are [American businessman and co-owner of Khanty Mansiysk Oil Corporation till 2003] John Fitzgibbons, [founder of investment company Brunswick] Gerard De Geer and some other international investors. Then the company took up some loans from western banks and investment funds. Part of the money was used to buy two Uralmash divisions: Uralmash-Drilling Equipment and VNIIBT-Drilling Tools. The remainder was reserved for acquisitions planned for 2006 or invested into development of companies already acquired.
- What are plans and lines of development for your company?
- We expect growth based on investments we have made and increase in orders. The above mentioned Uralmash divisions are already demonstrating substantial growth. When buying Uralmash-Drilling Equipment and VNIIBT-Drilling Tools, we envisaged a serious increase in drilling equipment orders. You understand that over the past 15 years this sector has seen no or little investments. To compare, in 1980-ties Uralmash was annually producing an average of 200 drilling rigs for domestic market. In 1992-2005 the average production dropped to 10 rigs, major part of which was purchased by Surgutneftegas that had never spared efforts to rebuild and reequip its facilities.  All other companies used rigs manufactured in 1980-ties, and drilling operations decreased four times over the period. So I believe that in the near future the market should grow 3-5 times. As soon as the next year Uralmash’s revenue will rise 2.5 times (without Drilling Equipment division). Our geophysical division  experiences a 60% operations increase. Drilling operations are growing as production rate grows in Timano-Pechorskaya province, one of our key regions. This year we have not bought any workover businesses because we have been creating our own workover division. Integra KRS, which is one of our companies, currently has 33 workover crews, and it is going to have 50-55 before the year’s end.
- And which service businesses yield more profits?
-Virtually, all of them (80% of the whole service market) have the same margin.
- What is the margin rate?
- EBITDA margin is about 10% to 20%. We are interested in three lines of business: drilling and related operations, capital and current workover, geophysical operations. In machine-building we have Uralmash-Drilling Equipment and [VNIIBT] Drilling Tools. We have plans for some acquisitions in this industry in 2006, primarily in oil service equipment production.
-Which shares will be offered to investors if you company takes the IPO decision?
-I can tell you for sure that these will not be our shares, it will be an additional issue. That will give our shareholders a chance to buy more of the company shares as they believe in this business’ future.
- Do you think that oil companies’ current strategy to sell their service divisions is feasible?
-Oil service and oil production businesses are profoundly different and their consolidation within one company  can be  hardly recommended. This has been proven by global trends. We are now in the middle of a transition process: just eight years ago no one intended to sell one’s service business and in another eight years oil companies will focus on their core business. This is supported by the following facts. In 2000 90% of all service operations in TNK-BP were  performed by the company’s own strength, whereas now shares of internal and outsourced services are approximately the same and I believe that by the end of 2006 the ratio will be 40% by 60% in favor of independent services.  As recently as 3-4 years ago, when I was head of TNK-BP  Central Tender Committee we had to choose between our own monster-like service division and three or four small companies whose services left much to be desired.  Today there are several strong companies in the market: Ufa UBR, Megionneftegasgeophysica, NIzhnevartovskburneft, which are still “internal” companies but they offer competition to SSK, Eurasia and Integra.
-There is much talk about pending consolidation of the service sector. But none of major market players except Integra seem to buy smaller competitors…
- All have different development strategies. Consolidation is not necessarily done through buying and even what we do is not just purchasing small companies. For example, Eurasia, which was initially based on a larger asset – Lukoil-Drilling, aims at organic growth, while Integra had no other way to go but buy basic companies to start organically develop them. Whichever course of development major companies choose, industry consolidation will be the outcome. Small-size players who will fail to provide quality services will die away. They will not be able to exist in a capital-intensive service business where one drilling rig costs about 10 million dollars. Major western service companies’ turnovers are billions of dollars. Probably, Russia’s leading players will strive to reach this level. 
- Do Russian service companies have a chance to enter international markets?
- Toda we can see that  Russian companies successfully operate for example in Syria, India, Iran and other countries. Mass expansion should be expected in 3-5 years time.
- In which markets?
- At first conventional ones – CIS, and then wherever, say, Venezuela, Middle East. Russian-manufactured equipment price  is highly competitive and our task is only to do away with  the 10-15-year lag of our equipment behind similar western equipment.  We have a big potential,  our specialists are as well qualified as western specialists. There is evidence that countries like, say, Canada that 20 years ago did not have their own service sector now have a 70-80% share of internal market and also are entering worldwide market.
- But Russia is not Canada, and Russian and western business environments are incomparable. How widely spread are kickback practices in oil companies?
- Today the market remains highly nontransparent but , say, seven years ago it was far less transparent. There appear companies like TNK-BP, Lukoil with ConocoPhilips that will develop new standards in the industry. Tendency  toward more transparency in the sphere of supplies is quite evident. But I believe the state should be more active in punishing kickbacks and bribes. Today bribed employee can be fired but criminal cases are normally terminated.  Such people can build new careers in other companies as there are no such a “black list” in the market. However, the situation is changing and many companies change the rules of the game.
- There is much argument about the idea to create a national service company. What is your opinion of it?
- I think there are spheres where the State should play bigger role. The State is retaining control over some industries and to my mind, there are areas in the oil service sector where the State’s involvement should be welcome. These areas are, for example, Arctic offshore seismic exploration, strategic fields data. Probably we should talk about partnership between the State and the private sector.  And by contrast, there is no need for the State involvement in areas with strong competition like drilling, geophysics.
- Does that mean that you do not support the idea of a national service company as it was offered?
- I believe this is a kind of utopian idea, which nonetheless is useful. By the way, I like the ideas of Yury Shafranik. He does right things: he tries to draw the State’s attention to the industry and demands support for domestic companies. Machine-building and oil service are the motive power of economic development and cash should flow from the oil industry to these sectors. The outcome may be creation of a successful export-oriented industry like the  one in Norway. There were times when the country’s authorities settled down to a course of protection of home service industry and now local companies have a 70% share in all offshore operations in the country.
- What are the implications of Russia’s joining WTO to the local service market?
- I do not think that there is currently any serious support of the service industry that can be lost due to the country’s joining WTO. Fundamentally, it is not needed. What the industry needs is an influx of efficient owners and new investments but not at all protection.  Duties on import of equipment remain sufficiently low but Russian rigs are still competitive enough. That is why I do not think that joining WTO will kill Russia’s service industry or machine-building. Quite the contrary, this will give us better export opportunities.
- A short time  ago the Russian Association of Oil and Gas Engineers proposed to develop a system of minimum payment levels aimed at supporting effective companies in the industry. How realistic is that?
- It is not possible for several reasons. First of all, there are hundreds of companies in the industry that compete with each other. Secondly, oilfield services are so inherently diversified that fixing some minimum prices is absolutely unrealistic. On the other hand, large oil producers reject ineffective service companies that offer 20-30% lower prices, inferior quality and poor safety. Damping should be dealt with administratively, which is both requirement and goal of customers.
- Can the latest initiatives on Mineral Extraction Tax and oil industry stagnation affect further development of the oilfield service sector?
-Given the oil price higher than 25 dollars, oil companies can develop successfully in the current environment. They will keep drilling volume at the same level until oil prices drop to 18-20 dollars per barrel. Workover and geophysical business are unlikely to be affected.
- But rate of Russian oil production is slowing down…
- Potential of previously developed so-called “brown” oil fields is being exhausted and there should be a boom of newly developed fields to replace them. Unfortunately, we face  a several years lag caused by uncertainty about who in the long run will produce oil in East Siberia. East Siberia may serve as a replacement of the West Siberian province but there should be a single operator who will work out an integrated project of field development, pipelining, etc. There should be one manager. Let it be the State or a consortium of local and international companies. Besides, Sakhalin offshore fields are beginning to produce first oil. All that will help conquer stagnation and raise production rate.