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Integra brochure
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May 31, 2005

Horizontal Drillers

Oilfield service companies are consolidating outside integrated oil companies
Hydrocarbon production
The necessity to consolidate companies providing drilling, workover and other services to the oil and gas industry is getting more and more acute. The majority of Russia’s emerging oilfield companies, such as Eurasia, Integra and Russian branches of world oilfield service leaders Schlumberger, Halliburton, Baker Hughes, etc. are supported by foreign capital. The phenomenon was termed “shclumbergerization”. Schlumbergerization can only be opposed by oilfield service companies with predominant presence of national capital. However Russia has a maximum of 5 years to set them up, and a substantial government support is vital for successful operation, according to the Halliburton and Schlumberger experience.
Within Eyeshot of Security Council and State Department
Russian oilfield service companies’ estimate of the local oilfield service market varies within $6 bn through $10 bn per year. It is worthy of note that there are no summary data on what the market structure is and how major players and service types are ranked by market share. The Oilfield Services Union said it is making enquiries at the request of the Russian Security Council, but still cannot describe the industry with regard to quality and quantity.
Kommersant got hold of only one document containing some figures that is an official document of the US State Department, which said that 70% of oilfield services is performed in-house by oil companies, independent Russian oilfield service companies account for 20%, and foreign companies’ share is 10%. The US officials note a great potential for the US oilfield companies’ further expansion in this market. According to the document, the Russian oil and gas sector annually imports  $1 bn worth of equipment and services, with the US share of  $230-250 mln.
 It is not coincidence that the US State Department focuses on the Russian oilfield services sector. Throughout the world, this industry is a terminal for cash transfer to other industries including high tech ones. Oilfield services include seismics, drilling, field development plan, field development, workover, well stimulation, etc.
Chances are that the Security Council’s recent interest in the Russian oilfield service sector is provoked by none other than the so called schlumbergerization, that is vigorous activity of the US companies (termed after Schlumberger as the largest of them) in this sector. Last year, Schlumberger arranged the takeover of Petroalians that was its main Russian competitor (see interview with Petroalians president Alexander Dzhaparidze) with annual turnover of about $250 mln. Schlumberger successfully works with practically all of Russia’s oil majors. Baker Hughes, another American company, recently established a large service center in Yamalo-Nenets Autonomous District. Other US leaders such as Halliburton, Weatherford, BJ Services, Parker Drilling also are expanding their business in Russia.
And finally, western capital is behind two more companies that have been actively buying up oilfield service assets divested by oil producers: Eurasian Drilling Company (25% plus one share is owned by Alexander Dzhaparidze) and Integra Group (see interview with Integra president Felix Lyubashevsky). The global oilfield service leaders seeking to expand in Russia caught their breath only once – when in October 2004 Schlumberger had to withdraw from the fields of its major Siberian customer Yuganskventegaz. However, today Schlumberger and other former contractors of Yukos are successfully operating in the Yugansknefetegaz assets, said Vladimir Voevoda, head of Rosneft’s  information department.
Service for oil producers
The Russian oilfield service market is currently a market of buyers, especially when oil producers continue to perform the major part of services in-house. The active sale of oilfield service divisions by oil companies that analysts predicted in 2001-2002 never happened. “The majority of our employees work in the oilfield service subsidiaries”, said a source in TNK-BP. “And TNK-BP is the only customer in many regions where they operate. We are aware that the western companies’ position is that oilfield services should be divested, but we consider the social aspect of the issue”. Still, both global and Russian experience strongly speaks for outsourced oilfield services.
Large independent oilfield service companies are able to invest heavily in technology development and benefit from selling these advanced products to their customers. As a rule, oil producers are not interested to invest in R&D, and the state ceased to finance them as far back as early 90-ies. But it is advanced technologies that enable oil producers to enhance oil recovery and increase reserves when some fields are depleted and others are hard to access. And it is advanced technologies that largely determine company’s capitalization. It is notable that the major customers of western service providers Yukos and Sibneft had the highest production rates in recent years. “Other things being equal, cost of advanced drilling is 1,5-2 times higher than that of conventional drilling. But the performance of this well is comparable with performance of four conventional wells. Benefits are self-evident”, Sibneft press-service said.
All interviewed specialists confirmed their expectation that integrated oil companies will sell their oilfield assets within the next 3-5 years. The process gathers pace, more companies get involved. Thus, LUKOIL sold its LUKOIL-Drilling to Eurasian Drilling Company in 2004, and Rosneft sold four floating drilling rigs. “Rosneft has strategic plans to divest oilfield service divisions, but it’s too early to speak about any specific measures”, Vladimir Voevoda said. The only exception is probably Surgutneftegaz who buys foreign equipment and technologies and using in-house services. Strategically, oil companies are interested in competition of independent oilfield service companies and they do not hurry to express preferences. It is mostly foreign companies who compete in the high tech oilfield service segment, while less technologically advanced segment is represented by both Russian and foreign firms. And finally, the low tech segment is dominated by local companies, though experts point to increasing number of Chinese firms with a competitive advantage achieved through using leasing schemes that were created in PRC for the purpose of industry development. In recent years, independent local oilfield service companies operated largely at a loss or with little profit. Experts interviewed by Kommersant estimate that the Russian oilfield services market is at least 10-15 years behind the world market in terms of technologies, though some local companies have been making use of western advanced solutions. “The number of western companies varies depending on the ability of locals to provide these services”, said a source in Sibneft. “For example, 5 years ago such works as horizontal drilling, hidrofrac and well stimulation were mainly performed by western firms. Currently, Russian companies are sufficiently good at using these technologies and Sibneft can reduce costs inviting local oilfield services, with quality remaining high”.
Moscow vs. Huston  All interviewees agree that the Russian oilfield service sector badly wants consolidation, and in 3-5 years time when local oil producers finally split off their service assets, a maximum of 10 large competing companies will compete in the industry. Besides, there will be a lot of small and highly specialized oilfield service firms competing in their own niche. They all will be operating for the most part on western technologies or a mix of local and western solutions. Properly speaking, on the example of the Huston-controlled Schlumberger you can see that efficient technologies have always been international: the Schlumberger brothers were French. The questions is whose capital will be used to finance these 5-10 oilfield service companies and whether the generated value added will benefit the Russian economy. Absolutely all experts point to the highly competitive environment setting up in the Russian oilfield service sector, but still western companies have a competitive advantage of their interests being lobbied by their governments, primarily by the US administration. The ties between the George Bush administration and Halliburton are well-known and they proved out during the overthrow of Saddam Hussein’s regime. On the back of this, there has been much debate among the industry professionals on establishing national oilfield service company. However, there is no unanimity in different circles on what it should be like.  The Russian Union of Oil and Gas Producers speaks for public companies with Russian but not necessarily state capital and possible participation of foreign partners (see interview with chairman of the Union Yury Shafranik).Others see the national oilfield service company as based on state-owned assets consolidated as the federal center’s policy instrument, like Rosneft or Transneft. “Within the united national oilfield service company we should establish strong production and engineering capabilities including construction facilities, and integrate into it a number of strategic companies”, says president of the Oilfield Services Union Igor Melnikov. “The partnership of companies that would compliment each other in their respective areas, support from national oil producers and mandatory legislative support will enable local manufacturers successfully compete with major international corporations”. Under the circumstances, establishing of national oilfield service companies of any type calls for state support. “Being the largest oil producing state, Russia does not have companies that can compare to Halliburton”, Melnikov says, “and it will not without the state’s assistance, because oilfield service assets are not core business for oil producers and are divested, upon which they either go bankrupt or are bought by foreign companies”. The Oilfield Service Union hopes to push the idea of the national oilfield service company through the Working Group on Natural Resources Protection of the Security Council of the Russian Federation. “In general we are positive on setting up the national oilfield service company, but it is too early to offer any detailed assessment because the proposal is not finalized yet”, Rosneft spokesman said.
“Service is no waste of money but a good investment” Interview with Petroalians president Alexander Dzhaparidze
- What changes occurred in the Russian oilfield service market over the past years?Over the last couple of years oilfield producers have changed their attitude toward the oilfield service business. Both private and state-owned oil companies finally developed an understanding of what we tried to bring home to them: oilfield services business is no waste of money but efficient investment in the core activity regardless of  oilfield services cost. Oil producers used to be much concerned over the cost of horizontal drilling that may exceed $1 mln. Now they focus not on absolute figures but on payback period. We have technologies that allow to achieve payback within just 6-9 months. Efficient oilfield services are critical for incremental oil production in the country. -How serious is Russia’s technological backwardness in this sector? Rather serious. It is primarily due to the lack of investments in the past decades. Oilfield technologies are comparable in complexity with space technologies, and only companies with large turnover, such as Schlumberger and other world leaders can afford to invest hundreds of millions to a billion dollars annually. Consolidation is the only way for Russian companies to regain ability to invest into technology development. Of course, there is the investment component in the rise of oilfield service prices currently being observed in Russia. But I am sure, to reduce the huge technological lag, Russian oilfield service providers will have to use mainly western technologies. - Does it mean that the Russian oilfield service industry will depend on western technologies? The present-day world does not know any technological dependence, for business itself became transnational, international, and the oilfield service business is no exception. Both state and private companies are interested to use the most efficient technologies, whoever the inventor. All oilfield service companies sell technologies with great pleasure, after all it is the seller and not the buyer who is in a subordinate situation in the market.- What are the “technological considerations” behind your decision to sell the Petroalians shares to Schlumberger in a stepwise manner?  Like other company managers, I cannot imagine the company’s future without access to latest technologies, and this is one of the motives behind the sale along with the shareholders’ desire to capitalize their assets. The Schlumberger deal opens the doors to all of the company’s technologies.  Surely, Schlumberger was after taking out of the way his long-time and major competitor, but we like the terms and conditions they proposed. - In summer you will cede a 25% stake In Petroalians and control of the company to Schlumberger. What impact will the deal have on Petroalians and the oilfield service market? One of the attractive terms of our agreement with Schlumberger provides for keeping Petroalians brand name, as it is a company with established reputation and business practices. Schlumberger’s structure will remain the same in Russia, too. We are not obliged to use only Schlumberger technologies, therefore we will continue make use of proprietary solutions. Important thing is that we have committed to increasing the Petroalians share of the Russian market, and we will work towards this goal. To be more specific, the Russian oilfield service market will become even more competitive.
“Russia should cash on oilfield service, not on oil” Interview with chairman of the Union of Oil and Gas Producers Yury Shafranik
- What are the top priorities of the Russian oilfield service market development?The oilfield service in itself is not significant. For the state, it is an important element for economic improvement. It is a tool to reduce oil producers’ costs, a ground for new technologies and equipment as well as the key to the dilemma: the raw material producing Russia or not. This sector may and should become a terminal for cash transfer from the oil industry to other industries, so that Russia cash not only on oil but also on technologies and equipment. Local raw materials and funds plus western specialists, equipment and technologies will get our economy nowhere. Another option: Russian raw materials, technologies, equipment, specialists plus western capital will certainly lead to overall economic revival. The solution lies somewhere in between the two options, but if we do not reach for the second one, nothing will change in the economy. - What is the practical way to develop the Russian oilfield service industry? The government should set the tune at the early stage: when granted a license, oil producers should be encouraged to work with oilfield service companies. Tax incentives may also be applied. In future, the market will regulate itself. A case in point is the Norwegian experience: 30 years ago there was no oil and gas sector in the country’s economy, but after the commencement of oil and gas production the government fixed obligatory quotas for local companies and international joint ventures, thus promoting development of the vast sector of oil and gas technologies that are in demand throughout the world.  - You have proposed to establish the national oilfield service company. What is the idea behind it? I see the national oilfield service company as an instrument of state control and a means of achieving economic revival through the raw materials sector. I would like to stress that by the term of national oilfield service company (and there can be several of them) I mean large public companies with Russian capital. This capital should be established by a group of investors and not by a couple of private individuals who may flee abroad some day. I bet, if the companies get state backing, investors will turn up. Such as the Pension Fund, Sberbank. The Russian capital should be at least in 51% of the companies’ s shares, however foreigners, too,  may be partners or minority shareholders. How will the state participate in the initiative? Primarily, through the public-private partnership.- What practical steps do you take to establish the national oilfield service companies?We promote the initiative through the Chamber of Commerce and Industry. We have got verbal support from the Competitiveness and Entrepreneurship Council of the Government. The national oilfield companies can be based both on assets divested as non-core by oil producers and on investments. As an example I can mention OTO oilfield service company that split away from LUIKOIL long ago. Investment and finance group Soyuzneftegaz (controlled by Yury Shafranik) has undertaken a project to create two oilfield service companies. Things are underway, you see.
“The future in the Russian oilfield service industry belongs to hybrids”
Interview with Integra Management president Felix Lyubashevsky
- Integra emerged in the Russian oilfield service market early this year. Could you share your perspective on development options of this business? The Russian oilfield sector has long needed consolidation. In three years’ time there will be 8-10 players in this market that will compete for 70-80% share; these will be both Russian and western companies. Today, consolidation trends have surfaced in some centers including Schlumberger and Eurasian Drilling Company based on LUKOIL-Drilling. Integra is a Russian oilfield service project comprising three lines of business: drilling, workover and geophysics. With assess to funds from major western banks, we have acquired, since the start up early this year, four private oilfield service companies with annual turnover of $60 mln. Before the end of 2005, we plan to invest additional $40 mln both in new equipment for existing assets and in acquisition of new oilfield service firms if interesting offers turn up. We plan to achieve a turnover of $200-300 mln before the year’s end. - You mentioned that independent oilfield service companies will soon have a 70-80% share of the market. But the example of TNK-BP where you for quite a while served as vice-president for oilfield services shows that large companies do not hurry to get rid of their in-house oilfield service divisions. Oil producers’ biggest concern is that outsourced contractors may not properly perform the work they perform in-house. Indeed, currently there are no independent players that would not manipulate the market but would compete without loss of quality. But to develop this market, oil producers should sell their oilfield service assets to make them independent, and at the same time give them orders through bidding process with participation of external contractors.  This process is underway in almost all integrated oil companies. - How do independent oilfield service companies build their relations with customers? There are three models. The first two are based on no-repeat orders: order is secured through a bribe or dumping price that deprives contractor of the opportunity to invest into development. The third model is unfortunately not wide spread but it is the model of the future: it’s building long-term relations with the customer. The model implies that there is interdependence between customer and contractor, which should be achieved if we want to abandon the existing sellers market. - What is your attitude towards increased western content in oilfield services, or in other words, schlumbergerization? I believe, there is no risk of total schlumbergerization, and its extent is determined by the market needs. Today in Russia western oilfield service companies’ share in the high tech segment is only 40%. The rest is conventional services performed by local companies that were bought by foreign firms, for example Siberian Geophysical Company, Yukos’ former division. In fact, conventional Soviet-Russian equipment and technologies account for 80-90% of the market, and I think here Russian companies are more than enough competitive compared to western counterparts. Many Russian technologies are fairly efficient and inexpensive, which makes them very attractive not only in Russia but in cross-border markets. Also, Russian oilfield service companies now use western technologies, equipment, chemicals. And vice versa, Schlumberger has launched production of western design perforators in Russia. Therefore the hybrid of Russian and western technology solutions may be the most successful in oilfield service companies.
Interview by Ivetta Gerasimchuk