Development of the domestic services market – from russian service company’s perspective

DEVELOPMENT OF THE DOMESTIC SERVICES MARKET – FROM RUSSIAN SERVICE COMPANY’S PERSPECTIVE

A review of the present-day state of the services market in the Russian oil and gas upstream industry leads to the conclusion that despite a more than 10-year history, this market is still in the formation stage and differs substantially in its structure from a services market as it is perceived in the West. According to various estimates, the capacity of the services market in Russia in terms of value stands at $5.5 billion – $7 billion per year. Foreign service companies account for 15% of this market capacity, 5% - is the share of Russian independent service companies and 80% - were carved out by oil and gas producers’ internal/closely-held service divisions. According to analysts with Russian Petroleum Investor company, there exist about 300 independent service enterprises in Russia today, 50% of which are geophysical (seismic survey and logging) entities, namely, structures that were not part of oil and gas producing organizations in Soviet times as well. Understandably, given this market structure, it is impossible to speak about fully-fledged competition, simply in virtue of the fact that price formation in 80% of the sector is not fully market-driven. Efforts to spin off internal service divisions from oil and gas producing companies, which went under way about two years ago, are a pretty slow-going process. This tardiness is associated with a variety of reasons. One may list among them, in part, the lack of adequate information and, as a consequence, limited opportunities to evaluate the real cost of the potentially interesting assets, or considerable expenses on performing an outside audit. The second reason is the relatively low level of technology possessed by the majority of domestic service structures, which requires sizable expenses on re-equipment and modernization, the expenses that are comparable to and frequently exceed expenditure on assets acquisition. The third reason is as yet limited investment opportunities of domestic service companies, which do not enable them to expand through acquisition of new assets. Nevertheless, the services market formation and structuring process has invigorated after oil companies began shedding internal service units from their structure. Changes in this sector are under way in two directions – the take over of the spun-off divisions by independent companies and consolidation of small service firms into larger structures. The speed at which these changes are occurring leads to the conclusion that formation of the market will basically be completed in two to three years.

If a comparison is drawn between Russian service companies and their foreign rivals that have a presence on our market, it needs to be pointed out that only Western heavyweights such as Schlumberger, Halliburton and Baker Hughes actively operate in the Russian services sector. The rest of the foreign companies are engaged principally in the supply of equipment. The afore-listed companies are integrated entities offering all necessary types of services. Virtually all of the domestic service companies have narrow specialization, which tangibly limits opportunities for competition. At the same time, there exist Russian service enterprises that operate successfully in the hydrofrac, seismic survey and logging spheres and challenge competitors in their niches of operation. But this competition unfolds basically at the regional level. If one is to speak in terms of the industry scale, we do not see any firms coming to seriously rival Western companies. This weak competitive position is linked with virtually incomparable financial and technological potential of national and foreign companies. Until recently, one of the competitive advantages enjoyed by domestic companies was their employment of specialists who have good familiarity with local conditions. But since Western firms active in Russia today recruit personnel from the same sources as Russian enterprises – these are three to four major educational establishments where specialists for our sector are trained – the competitive advantage is gradually withering away. Western service companies’ competitive strength associated with their financial wherewithal also lies in the volumes of their investments in research and development efforts that surpass significantly investments by our major vertically integrated oil companies. Virtually the sole advantage enjoyed by national service enterprises is the lower level of prices, but in our view it is not a strategic advantage because operation at the limit of profitability does not enable an enterprise to develop. As for PetroAlliance, we differ from the rest of the Russian players on the oil and gas services market in that from the very beginning we have been utilizing Western technology and our prices are comparable with the Western level of prices. Therefore, our main competitive advantage over foreign services giants is better knowledge of the technological requirements and peculiarities of the Russian market. Similarly, in possessing technology comparable to Western know-how, we can utilize it far more effectively. Our second advantage is that we speak with the customer in one language, both linguistically and from the perspective of the business-approach, including in terms of understanding their problems and tasks.

Oil extraction conditions are being complicated because of both the need to prospect for, explore and develop fields in hard-to-access geographical zones and increasingly stringent ecological requirements. In this situation the task of enhancing the efficiency of oil production is being moved to the fore – it is imperative to lower costs per unit of output, which in turn has a direct relation to the oil industry services sector simply because services account for the larger part in the structure of expenses on prospecting for, exploration and development of fields. Types of work associated with acquisition of information – seismic survey and geophysical study of wells – are taking on particular importance. It is not enough to possess modern drilling or enhanced oil recovery techniques, one needs to have a clear notion of conditions and objects at which these techniques should be employed in an optimum way, and it is impossible to acquire this knowledge without using geophysical methods. In other terms, efficient utilization of advanced technology is possible only on the basis of comprehensive use of the entire range of methods currently possessed by service companies. It is precisely these approaches that are yielding impressive results today. Who would imagine just several years ago that, for example, fields in Western Siberia that have been in development for decades can produce flow rates of almost 1000 tons/day.

Unfortunately, the present-day state of the services sector of the Russian oil industry does not fully match modern requirements and it represents one of the areas that alongside the ongoing restructuring offers good prospects for growth. Starting from the moment of its formation, PetroAlliance has been engaged primarily in bringing modern, predominantly Western technology to the Russian market. So, we know this subject well, as they say, from the inside. The peculiarity of our market amounts to its full readiness, amid inadequate saturation with state-of-the-art technology, to make a technological leap in terms of introduction, development and adaptation of leading-edge techniques. This conclusion is associated to a considerable extent with the fact that in terms of science we have always stood on advanced positions. It is an open secret that the majority of ideas behind the technologies that saw the most spectacular success, such as three-dimensional seismic survey, many types of well logging, hydrofrac and horizontal drilling, to name a few had evolved in the former Soviet Union, but this scientific excellence was converted into technological processes and services in the West, primarily in the United States.

If one is to speak about PetroAlliance’s development strategy, we have accomplished the tasks set to the company in 1998 in the process of our transformation into an independent service company. PetroAlliance has reached today a point in its development whereby at each stage in the field exploration and development we can provide to the customer all necessary services: seismic survey, provision of related services in exploration and development drilling, well servicing, optimization of production. We have finalized the formation of an integrated services company. We have substantially expanded the geography of the company’s operations and a range of customers. In the traditional oil producing region – Western Siberia – our projects are linked with the entire spectrum of services to optimize well operation. These services encompass well stimulation, servicing and overhaul, hydrofrac, and repair-insulation work for such customers as LUKOIL, TNK, Sidanco, Yukos and others. We pursue vigorous operations in promising regions where upstream operations are in full swing. Our company has performed an extensive exploration work (seismic survey, related services in exploration drilling, design of structures and models) for LUKOIL in the northern Caspian. PetroAlliance’s projects in Azerbaijan are linked with seismic survey and well servicing. On our further plans are geological exploration operations in the Kazakh and Turkmen sectors of the Caspian Sea as well as winning orders already at the stage of Caspian fields’ development. Work in Timano-Pechora is likewise a priority for us, since this region has a giant potential. In the more distant future our expansion on the services market will be associated with projects in Eastern Siberia and on the shelf of northern Russia.

The company has plans to boost its presence on the services market, pursue further diversification in terms of the geography of operations and customers, and achieve a sizable increase in capitalization, which will enable us either to take the company to the international stock market or find a serious strategic partner.