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February 29, 2008

Lev Goldenberg: Eastern Siberia cannot be assimilated without mutual understanding

Even today, when construction of the Pacific pipeline has become reality, disputes about the prospects of Eastern Siberia as a new oil recovery and service region, have not ceased.  Moreover, commissioning of the major pipeline has been postponed.

And yet the service providers represented by major market players continuously approach the new region and make prospecting wells for their customers in  the areas where no drilling has ever been performed.  These pioneers have labeled their wells “search items”, and they are hopeful that they will not miss their chance.  Nevertheless, although the drilling romance is there, oil recovery in Eastern Siberia has neither turned into a national idea, nor into the top priority of the oil recovery sector. This business has no solid financial basis. Against this background, the market suffers from the poor information supply about the plans pursued by oil companies and a tough pricing policy that fails to take account of the climate and the infrastructure of the region. Who knows whether the industry will be able to consolidate its efforts, when the gates are finally open? This consolidation needs cooperation, whereas each company has been acting like a selfish child.  We discussed the obstacles and prospects of the oil market in Eastern Siberia with Lev Goldenberg, Vice President in charge of Drilling and Integrated Project Management, Integra Group.

Corr.: Lev Rafaelovich, despite the statements made by major oil companies and varied government authorities, Eastern Siberia remains an oil terra incognita, and its short term prospects are quite vague.  Do you, a top executive of a leading company, have a clear idea of its potential development in the coming three to five years?

L.G.: Russian oil companies have no tradition to share their plans and prospects.  Unfortunately, we do not have enough information.  Therefore, our understanding of the situation is based on uncoordinated presentations and poor information obtained from informal meetings and conversations.

Nevertheless, the objectives of oil service providers in Eastern Siberia are more or less clear.

We are driven by the priorities preset by major companies.  There remain few projects at initial stages of their development in Western Siberia, as a major portion of oil fields there are in the final stages of their development.

Meanwhile, a number of major discoveries have been made in Eastern Siberia, therefore, intensive geological prospecting is performed there.  To my mind, all of us will have to join efforts in the next three to seven years to develop Eastern Siberia and to turn the region into new Western Siberia.  This is our agenda.  Just look at Vankor and the oil fields around it developed by Rosneft.  Gazprom is engaged in intensive development of its Krasnoyarsk and Irkutsk assets, Slavneft has started the development of the Koyumbinskoye oil field.  The Verkhnechonsky project is being successfully developed by TNK-BP. Unfortunately, development of Kovykta project has slowed down, but it may be resumed as early as in the third quarter of 2008.  Small companies that have obtained concessions in Eastern Siberia are also engaged in intensive oil recovery operations.  Finally, we look eastwards and address Yakutia.

Corr.: Speaking of Yakutia, when do you expect any marked developments in this region?

L.G.: We are expecting a boom there, but so far everything has been tied to “the pipeline”, and its construction.  As soon as it is ready, investments will flow into Eastern Siberia and Yakutia, and service companies will be there to share the market.
Corr.: Has your company chosen the wait-and-see position?

L.G.: Not really.  Our position in the oil service market is quite strong, and we have every intention to develop our business.  This year, we are going to move our drilling rigs from Western Siberia to perform the assignments provided by Gazprom, particularly, in the Kranoyarsk Territory.  We have performed assignments at Vankor oil field, where four clustered wells are being drilled under our supervision, and our program for the next year includes five clusters. Ee continue our operations as part of Verkhnechonsky project.  In 2008, we are going to drill four prospecting wells and four production wells on orders from four different customers.

Integra’s oil service business is in the process of intensive development in Eastern Siberia; therefore, other service companies accompany us there.  In particular, these companies provide cementation and directional well services.

However, we often cannot transport any hi-tech facilities that we need on site to successfully implement our projects and to reduce any associated risks, due to a total absence of roads.  However, we find it too expensive to store our equipment on site for 12 months, and this is another infrastructure-related problem that arises there and that must be resolved as part of a wide-scale investment campaign to be launched in this region.

Corr.: And still the expansion of both the principal and any associated service businesses in the region with poor infrastructure can cause problems.  Is this issue associated with any extra “bonus” payments on top of your regular contract fees?

L.G.: Good question.  Unfortunately, against this background, no customer considers any supplementary compensation payable to their service providers for the reason  of “unavailability of any kind of infrastructure”.  Today Eastern Siberia does not have any roads, housing, or electricity within areas whose dimensions exceed hundreds of kilometers.

Incidentally, two projects developed by Integra require the construction of two winter roads, 350-400 kilometers long, to have materials and equipment delivered.  And we have to be quick to have enough time to deliver the equipment, petrol and other loads while these winter roads are in place.  However, our customers do not consider any extra compensation for the complexity of our assignments. So far, they have been paying the same amounts as they do elsewhere.

Moreover, having completed one particular project in complete isolation, which is a regular occurrence in Eastern Siberia, the contractor remains in the forced isolation for the following winter season.  No customer is ready to offer any compensation.

I believe it happens because oil recovery companies do not consider development of East Siberian assets as their top priorities.

Corr.: How efficient are your operations in this region?  Are you expecting returns in the long run?

L.G.: These assignments can also be profitable, as the companies operating in the local market today will stay there tomorrow.  New projects will strengthen their positions.

On the other hand, we turn down any completely unviable projects; therefore, each of our Eastern Siberia projects is efficient, although certain trade-offs, if offered by our customers, could make them even more efficient.  Meanwhile, the customer is always right!

Corr.: In other words, do you maintain any rate of return applicable to Eastern Siberia projects?

L.G.: Sure.  Each project is considered on a case-by-case basis, and we make independent decisions whether to enter into a contract or to turn it down.  So far, no project in Eastern Siberia has been particularly efficient.  Limited financing is the cornerstone, as local subsidiaries of oil recovery businesses have limited financial resources available.  They neither retain, nor hide any cash, they just have small amounts provided by their parent companies, and they merely need more money.

Nevertheless, we can work and make money there today.  The problem is that the whole area is poorly investigated, and no one can say what comes next.  Therefore, we rely on our hi-tech services.  Preliminary estimates are positive.

Corr.: However, there are particular margins in place.  In other words, what annual assignments in Eastern Siberia can ensure their minimal efficiency today?

L.G.: It is quite hard to make these assessments on condition of unavailability of any infrastructure.  However, we have a well-grounded understanding that seven drilling rigs whose arms are 500 meters long are efficient, whereas five rigs are not.  If the arm is 1,000 km long, the profit margin requires seven to eight rigs in Eastern Siberia.  These calculations are made by our company.  Other companies may think otherwise, their calculations may be different, as they are mainly driven by the structure of their contracts.

This year we will operate nine rigs in the region.

Corr.: Given limited resources provided by customers in the regions, are you sure there will be enough workload for this fleet?

L.G.: Today, there is an excessive demand for drilling work in Eastern Siberia, and preliminary requests indicate that it exceeds the capacity of the fleet available in the region.  That’s why we believe that our projects will be profitable this year, as we have selected the most interesting of the whole package of proposals.

The point is that the large number of small companies that operate in well-known oil recovery regions have not arrived in Eastern Siberia.  Only major service providers can operate in Eastern Siberia today. The unavailability of any infrastructure and 100% advance payments made by customers require substantial resources and arrangements with other service providers, as initial project stages have to be financed by service providers.

Corr.: Does this situation cause any substantial deficiency of services?

L.G.:  I wouldn’t say that.  A sufficient number of companies that offer drilling-related services operate in the region.  Each major service market player is present there.  Some deficiency is still noticeable in the cementation sector.  Other issues are covered.  The competition is in place, and it indicates a regular business process.

Corr.: That is true, but will oil service providers be able to rapidly increase their capacities in the region to cover the demand that will skyrocket when the pipeline is completed?

L.G.:  I don’t think so.  We will not be able to cover the demand.  Foreign players are bound to come into the region.  Nabors and Deutag already operate in Western Siberia, and they are certain to expand their presence.  Parker Drilling is also closely watching the market.

If market growth is sharp in the next two to three years, rather than gradual in the coming five to seven years, even Chinese companies will enter the market to cover the demand.

Corr.: Do you believe that the presence of Chinese drillers in Eastern Siberia is the reality of the near future?

L.G.: You know, any contractor can do his job well if proper management is in place.  We consider the control over Chinese contractors a tough undertaking, particularly at initial stages, although nothing is impossible.  In a way, their strengths include sufficient staffing and low rates.  The staffing of one Chinese drilling team may reach 80 workers against 40-44 in Russia.  However, this is just an issue of quantity.

Corr.: How good is the management of oil service providers in the region?

L.G.: It depends.  As you may know, the majority of wells in Eastern Siberia, including prospecting wells, are drilled on the turnkey basis.  This fact is an illustration of the quality of control.  I consider my statement as the answer to your question.  The same applies to all other companies except TNK-BP.  This company is in control of each process.

Corr.: Do they succeed?

L.G.: Yes, they do.

Corr.: This is kind of an in-house IPM, a particular project management model?

L.G.: Oil companies need IPM if they cannot control all processes.  If an oil company is well developed, well organized and well structured, it needs no IPM.  This company has its in-house drilling department and an effective supervision service, capable of coordinating and tracing each process and its implementation.  Their strong engineering support ensures their prompt decision making.  Everything works well.

Why do foreign companies use this scheme, and the Russian customer cannot do it?  The only reason is the Russian tradition, although all companies have started setting up in-house departments and supervision services.  Some of them are successful, others are on their way, and some companies have just initiated this process.  Everything depends on the attention given by a company to this issue, whether the company is willing to be in control of these processes, and whether the company needs a high quality product.

The customer must know that no contractor makes his well.  The customer does it by himself and for himself.  Imagine, that you want to have a house built for your family and that you hire a general contractor who undertakes construction of your home.  I am sure you will follow each step taken by your contractor, check the materials that he uses, and, most importantly, whether this home is the one that you want.  I am sure that you would do it.

Corr.: If I could, I would.

L.G.: If you cannot, there is no need to build a house!

Imagine that the contractor has constructed a turnkey well.  Now it needs to be operated.  So what will happen if it is drilled incorrectly?  If it has so much mud in it that nothing is recoverable except this mud?  Shouldn’t the customer be worried about it?  And he is the best controller.

IPM projects are temporary, and they are performed unless and until the customer takes over the management.  No IPM project has lasted for over three to four years.  This time period is needed by the customer to develop his management system and train his staff with our assistance so that the customer can take on all of the responsibilities after that.

Corr.: What about the performance of traditionally “self-sufficient” companies, including Surgutneftegas and Gazprom in Eastern Siberia?  Will they get rid of contractors?  An agreement between Gazprom and Schlumberger has been announced recently.  What do you think it means?

L.G.: Surgutneftegas is a self-contained company that has its personal life cycle, and I believe that its growth rate prevents it from hiring any outsiders both now and in the future.

Gazprom is different.  The number of services within its structure is insufficient.  Therefore, the framework agreements entered into with Schlumberger or any other company are inevitable.

Burgaz is a strong service provider within Gazprom, and Gazprom has a strong prospecting section, and several other auxiliary service providers, though their number is limited.  That’s the reason why Burgaz hires outside services as a general contractor. However, Burgaz is behind Gazprom in terms of its growth; therefore, outsiders, including our company, get frequent orders from Gazprom.  We act as subcontractors of Burgaz, and this is no insult.  On the other hand, our IPM makes use of Gazpromís resources.

Corr.: Is there strong cooperation between service providers in Eastern Siberia?

L.G.: Except for the machine building sector, I believe that the cooperation between service providers is now insufficient, and it cannot ensure operation of a civilized oil service market.  Unhealthy competition is in place, and it is close to a local war.  The best method is negotiations leading to mutual benefits.

We use different resting bases by leasing them from other service providers.  And vice versa, we provide our bases to our colleagues to help them.  Sharing is more efficient.

Corr.: Let’s talk figures.  How much did the prospecting drilling charge in Eastern Siberia go up in the last 12 months?

L.G.:  Not much.  As a rule, the charge usually goes up by the amount of the inflation ratio that is accepted individually by each company. However, the market is different.  For example, cementing service charges have gone up because tougher quality standards require the use of more advanced machinery.  Diesel fuel has gone up by 30%.  Charges payable for each auxiliary service have gone up, and this growth exceeds the inflation ratio by far.

At the same time, the customer compensates us 12 to 15%.  We cannot raise our prices by the amount in excess of the above figures. 

Many spare parts and dispensable materials are purchased from the market.  This is how we purchase fuel and metal. And the prices go up all the time, therefore, we assume new risks, as we will keep purchasing these products in the course of the year at ever growing prices, as we cannot buy the above materials all at once.  Strange as it may seem, at the feasibility study stage of any project, no customer is willing to take this fact into account.

Corr.: What is your estimate of the market share of Integra-Drilling on the production and prospecting drilling market in Eastern Siberia?

L.G.: If the share of Surgutneftegas is not taken into account, our production drilling share is about 25-30%.  However, these figures are approximate.  Statistics is insignificant in terms of the amounts of oil recovered.  For example, in Vankor, wells are drilled on a stage-by-stage basis, and one stage is completed at ten wells, then the next stage begins.  And no assessments should be made on the basis of incomplete wells.  Production drilling is not yet widely spread in this region: this type of drilling is done at Verkhechonskoye and Kovykta fields, whereas Kuyumbinskoye field is to go into production drilling soon.

I believe that our share of prospecting drilling is 20% in Eastern Siberia, although this figure is a lot lower in Russia.

Corr.: Does your machine building sector keep up?

L.G.: No, it doesn’t.  Uralmash-Drilling Machinery has too many orders from oil companies, and if we place our orders with this company, we will have to wait for it to be implemented for over a year.  We are not happy about it, and this year we are planning to buy several mobile units made in China and equipped with U.S. drives and transmissions.  The metal and the work force come from China.

However, heavy items will be purchased from our company.  This is the only production facility capable of making top quality machines (160-220 tons) in Russia.

We plan to purchase 5 mobile and 1 or 2 heavy units each year to complete and to renew our fleet.

Corr.: Your purchases are taking account of potential operations in Eastern Siberia, which is not really efficient.  Will your investments pay back?

L.G.: We are still hopeful that the situation will improve.  Today we are an independent service provider.  And if in this situation no attention is paid to the existing problems and if our efforts remain uncompensated, our development will be extremely tough.

We believe that even today some oil companies want to develop their oil-related services, so that the high quality is paid for.  Oil service providers can only survive if the demand is in place.