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August 07, 2008

Valerii Bessel: “Service companies are heading for the CIS together with vertically integrated oil companies”

Integra Group of Companies wants to increase its presence in the CIS market from 13% of the annual gross revenue to 25% by 2012. This strategy is based on the oil and gas recovery growth rate anticipated for the CIS, which is higher than the growth rate projected for Russia, which translates into a bigger number of drilling assignments in CIS constituent states. Besides, Russian oil companies are reconsidering their position in terms of the CIS: although several years ago these states were mainly considered as the sources of cheap hydrocarbons designated for their resale to Europe, today, vertically integrated oil companies consider these states as investees.

Penetration of Russian oil service businesses into CIS states seems expedient due to the well-known integrity of the national economy that dates back to the days of the USSR; even now it is capable of synergizing development of the oil and gas industry within the territory of the former USSR.

Finally, while the penetration of western service companies into the post-soviet markets is limited due to a number of subjective reasons, Chinese companies pursue their aggressive policy of expansion. Local elites, being afraid of excessive presence of Chinese companies in this sector, often decline proposals made by Chinese companies and choose Russian contractors.

In other words, the Russian oilfield service sector has a substantial potential in CIS markets; Integra has identified several lines of business development in this market, namely, drilling rigs upgrade and IPM programs. According to Valerii Bessel (VB), Vice President of Integra in charge of Sales, interviewed by Servisneftegas Magazine, implementation of the above programs may substantially improve efficiency of the oil and gas sector in CIS constituent states.

Editorial Board (EB): Valerii Vladimorovitch, last year, Integra announced the establishment of its representative offices in Kazakhstan, Azerbaijan, Uzbekistan, Ukraine and Turkmenistan. What circumstances underlie this strategic choice?

VB: Our strategy is primarily driven by oil and gas recovery growth in these countries, both the growth that is observed today, and the growth specified in the national development plans for the medium term. Oil and gas recovery growth rate in the CIS states is projected to outperform the same rate in Russia.

Oilfield services market will be redistributed respectively in terms of the headway, well workovers, and seismic assignments, (see “Recovery and Headway in CIS states”, “Projected Oil and Gas Recovery Breakdown in CIS States”). Besides, the oil and gas sector of the “post-Soviet” territory still retains remnants of integrity, which may synergize development of this sector in the CIS territory. This potential is evident today, and, to my mind, soon Russia and other CIS states will enter the world market as an integrated market player. The integration trend is noticeable today, in particular, it turns evident due to a step-by-step transformation of attitude of major oil companies to the CIS states.

2006 oil production and meters drilled in the CIS countries
Country Oil output (million tons) Gas output (billion cubic meters) Meters drilled (thousand meters)

Kazakhstan 64,7 25,6 1 215,5

Azerbaijan 32,3 6,8 151,4

Turkmenistan 8,55 65,1 455

Uzbekistan 5,4 55,6 450

Ukraine 4,5 20,8 434,2

CIS (without Russia) 115,45 173,9 2 706,1

Russia 480,5 656 12 304,9

% CIS/ Russia 24% 27% 22%
Source: FSU Oil and Gas Statistic Yearbook, RPI, 2007; MINTOP #1 2007, Energy CDA

Forecast dynamics: sharing of oil and gas production in CIS
2006 2030

Russia, % Other CIS countries, % Russia, % Other CIS countries, %

Oil output 76 24 51 49

Gas output 73 27 57 43
Source: Energy CDA

Forecast oil and gas production in Turkmenistan
2007 2015 2020 2030

Oil output (million tons) 10 30 50 110

Gas output (billion cubic meters) 72 160 175 260
Source: Ministry of Oil and Gas Industry and Mineral Resources of Turkmenistan (data as of March 2008)

Rig fleet renewal: upgrade or buy new ones?
New rig Upgraded rig

Quality Advanced high-quality rig equipped with TDS, foreign-made cleaning system, diesel power station, and control system. Packing with modern high-quality Russian and foreign made equipment

Cost US$ 30-35 million (load capacity 450-500 tons) Depending on the type of upgrading - from US$ 5 million to US$15 million

Production timeframe 1-2 years 4-8 months

Depreciation expenses Yes No (depreciation attributed to netback)

Adaptation to customer needs Moderate Full

Efficient old rig fleet use No Yes

Equipment diagnostics No Yes
Source: Integra Group of Companies

For example, five or six years back from now Gasprom considered Turkmenistan solely as a source of cheap gas to be bought by Russia and resold to Europe. Today this country turns all the more attractive as a strategic investee. Investment-related interests pursued by Russian oil companies serve as the principal waymarks for our oilfield service strategy development.

EB: Although CIS states have ambitious plans concerning increase in the oil and gas recovery, they do not have the capacity to intensify their drilling. Evidently, drilling market growth will require involvement of both Russian and other foreign market players. What players in particular?

VB: It is true that no CIS state has excessive drilling capacities. Ukraine is the sole exception, however, excessive capacities may be available in the future due to insufficient drilling efficiency. As for the principal market players, first, major western service companies operate in CIS states, and the process of their expansion is likely to continue in the future. Meanwhile, expansion of western companies in the CIS market will restrain the process of transfer of this sector into the state ownership. Second, CIS markets also have Asian market players, and patterns of their behavior are different from those of western companies. Companies based in Korea and Japan are utterly cautious in terms of any projects implemented in the CIS, whereas Chinese companies, namely, the state of China, pursue a policy of aggressive expansion into the CIS. Can a Russian oilfield service company, even the biggest one in the country, successfully compete with China? This is kind of a rhetorical question…..

It may sound ironic, but the Chinese factor works for the benefit of the Russian companies: local elites, in their effort to prevent the “Chinese intervention” into the oil sector, tend to chose Russian oilfield service contractors.

EB: Today many Russian oilfield service companies make attempts to enter CIS markets. Is there any competition between them?

VB: Unfortunately, this competition does exist, and this factor prevents Russia as a state from entering this market and from occupying a strong position there. A consistent policy is being developed in terms of these countries. Therefore, we are hopeful that Russian companies will switch from confrontation in these markets to beneficial cooperation and market grouping.

EB: What about oilfield services charges set by various market players in CIS markets?

VB: The highest rates are charged by western service companies. Their rates are driven by a higher quality and by a bigger share of executive expenses within the cost structure.

Chinese companies, supported by the state funding, unlike their Russian and Western competitors, may implement dumping policies.

EB: This year, Integra made a proposal to the Government of Turkmenistan that consisted in the upgrade of their drilling machinery. Can this proposal be considered an alternative to the purchase of new drilling units?

VB: I’d say that the program for the upgrade of drilling rigs in Turkmenistan has no alternative options. By 2015, this country wants to triple its recovery, and by 2030 Turkmenistan wants to increase the output ten-fold I comparison with the year 2007 (see “Projected oil and gas recovery in Turkmenistan”). The wear and tear of their machinery reaches 95%; the average age of drilling rigs exceeds 20 years.

Replacement of drilling rigs  in Turkmenistan (in excess of 110 units) would require a one-time investment of USD 3 – 4 billion, and the oil sector has no “free” financial resources available in this country. Even if we suppose that Turkmenistan makes a decision to replace their drilling rigs, here comes the question: what country is capable of implementing this program within an acceptable term? According to our assessments, in a couple of years, Russia will be able of producing up to 40 heavy drilling rigs a year. This means that it will take our country three years to cover the needs of Turkmenistan, if no other orders are served. This is hardly ever possible. Of course, China is capable of replacing the fleet of drilling rigs for Turkmenistan within a shorter term, however, here comes the problem of “Chinazation” of Turkmenistan…..

The upgrade of drilling rigs will ensure introduction of new technologies and improve drilling efficiency against lower costs (see “Renewal of a fleet of drilling rigs: to upgrade the old units or to buy new ones?”) The upgrade of one drilling rig would cost USD 3 – 5 million on average, and if the installation of the overhead driving gear and slurry purification system are included, the upgrade cost would go up to USD 15 million.

The implementation of the drilling rig upgrade program will boost drilling, output, and financial resources, thus, setting the stage for the scheduled purchase of new rigs. A supplementary argument in favor of this program is the fact that about 90% of all operable drilling rigs in Turkmenistan were manufactured by the Soviet factory Uralmash.

In 1984 – 1992, Uralmash supplied 33 heavy drilling rigs to Turkmenistan (mainly, ZD-76), thereafter, supplies were suspended. Since 2000, 22 rigs have been delivered (model NBO-D (ZD-76). Today Turkmenistan has a number of sites where drilling rigs may be upgraded, and I am sure that we will be able to successfully implement this program.

EB: The company management considers IPM as the business that has a strong potential. The company has already implemented an IPM project in the Ukraine. Will any projects of this kind be implemented in other CIS states?

VB: We believe that IPM projects have a really strong potential in CIS states, as they minimize costs incurred by customers and substantially improve the efficiency of oilfield services, which is traditionally low in CIS countries. The average commercial drilling rate in the Ukraine is about 300 meters per one drilling rig a month; implementation of an IPM program made it possible for us to boost the drilling rate to 900 meters per one drilling rig for our customer – Cadogan Petroleum.

In the short term, we are planning to launch our well drilling management project in Turkmenistan. According to our assessments, this project will improve the drilling efficiency manifold.

Besides, we believe that incorporation of our joint venture between Integra Group of Companies and Smith International Inc. that is now engaged in provision of oilfield services through the application of the most advanced technologies and know-hows in Russia and CIS states, may substantially improve the efficiency of IPM projects and oilfield services.

EB: What interests does Integra pursue in the oil and gas market of Azerbaijan?

VB: We believe that the market of Azerbaijan has a strong potential in terms of our cooperation in oilfield services and supply of machinery. In 2007, Tumenneftegeofizika implemented a project in cooperation with GNKAR (State Oil Corporation of Azerbaijan). In the course of the project implementation, detailed 2D and 3D seismic prospecting was performed at the oilfields developed by Gobustan Operating Company. In the future, Integra is planning to ensure mutually beneficial cooperation with GNKAR in drilling, seismic research, well technologies. Further, we would like to participate in the implementation of the drilling rigs upgrade program in Azerbaijan, although we will have to fight for this market.

Besides, we’d like to cooperate in the implementation of personnel training programs, and to organize the exchange of expertise with the oldest Baku-based school of oil engineers. We consider Azerbaijan as the supplier of highly professional personnel for our projects implemented both in Russia and worldwide. Their shelf drilling expertise has a special value.

At the same time, the oil and gas market of Azerbaijan is highly overestimated, therefore, we should be very cautious in assessing the opportunities of Russian oilfield service companies there. We should bear it in mind that Azerbaijan is strengthening its positions under PSAs, while GNKAP launches its independent shelf projects, and these factors may complicate the entry of foreign players into this market.

EB: On the whole, what is your vision of Integra’s potential operations in CIS markets?

VB:  It’s up to you to judge. In 2007, the share of CIS states in Integra’s gross revenues was mere 7%, whereas in 2008 this figure went up to 13%. By 2012, this figure is to go up to 25%.