The recent years for the Russian oilfield service were marked by development of highly competitive market in the country. However challenging political and economic conditions bring adjustments in this process.
How does the oilfield service market develop in today’s Russia? What are the main trends and company plans for further development? Islam Nazaraliev, CEO of Naftagaz JSC answers these and other questions
— Islam, first of all I would like to hear your opinion on the condition of current demand for oilfield services. How would you describe it amid stabilization of oil prices at acceptable levels?
— It appears to me that there is no direct linear relationship between oil prices and the size of oilfield services market in our country. The fluctuations of oil prices generally affect this market indirectly with a certain time lag. Moreover, depletion of the resource base in traditional oil production regions at the brownfields objectively implies increase of oilfield services volume, primarily, in drilling, irrespective of whether the oil barrel is priced at 27$ or 77$, because you need to drill more to maintain the current level of production.
— How would you describe the current condition of the oilfield services market in Russia and what are its development prospects in your opinion?
— The market condition is determined by the impact of a number of mixed trends. On the one hand the impact of global trend for creation of high competitive oilfield services market through outsourcing of the main part of works to third party independent oilfield service companies has been seen in Russia over the last 20 years. During the investment boom in the 2000s many of our vertically integrated companies faced the requirements of international stock exchanges for divestment of non-core assets (construction, service, and social) as one of the conditions for successful IPO. Since then the inertia of this “push”, although weaker, still influences the market and supports the creation and development of oilfield service entities which are not dependent on the vertically integrated oil companies. At the same time starting from 2014 the consistent development of the market was somehow disrupted due to political factors, sanction pressure. In these conditions many vertically integrated oilfield companies, while seeking strategies for optimum hedging of short term risks, have corrected their production plans.
— What do you mean by saying “corrected their production plans”?
— I mean that some started to increase the scope of oilfield service activities performed by own efforts, some started to review options of hiring oilfield services contractors, but using the customer equipment, or other partner programs. This instantaneously narrows the market for independent service companies. Apart from the two trends that I mentioned, there is the third one to be taken into account. The point is that completion of the process for creation of vertically integrated oilfield companies produced some interim condition in the market. Simply speaking like in case of a marital breakdown they “divorced but did not live apart”. A pool of service providers and contractors has developed around each vertically integrated company. After 2008-2009 economic crisis there was an objective trend of breaking up such pools with subsequent transformation into a truly competitive market. The management and investors of some of the companies that survived the crisis recognized unacceptability of the situation when 70-100% of order portfolio is composed of orders of a former beneficiary, and focused their efforts on its diversification. Performance of a certain scope of works by the customer’s own efforts produces a certain pressure on the market both in terms of volume and content of services, and slightly slows down the transformation that I mentioned.
— How do you see further development of the market situation in light of the trends that you defined?
— I see 2 options. With the current prerequisites in the mid-term and long-term perspective the majority of the Russian oilfield service companies can be gradually squeezed out into the segment of low tech and low margin services. The lost ground will be filled by foreign contractors that owing to more flexible international structure, investment capabilities and access to cheap and long financing will take a dominant position in the market. Some believe that this is not a big deal arguing that “free market will do its job!” and some refer to the Middle East oil field service market, which has been existing and prospering in this state for 90 years. It appears to me that our country has a serious oilfield service legacy and deep traditions and it would be very dangerous and myopic to lose them. Whatever is good and convenient for small monarchies in the desert can be somewhat of a pistol to the head for our country with its role in the world. Since the collapse of the USSR many mindful people have repeatedly seen that the so called free market for some reason always “judges” to our disadvantage.
The second option is possible with a more active involvement of the government in resolving the issues of the industry including development of fair communication lines between its entities which will inevitably result in strengthening of Russian oilfield service companies, development of new technologies and the entire industry.
— In your opinion what should be done and by whom to correct the development vector of the trends defined by you?
— You formulated your question very diplomatically (laughing). Probably you expect that I will answer like “increase the tariffs, change the payment conditions, treat the oilfield services in a partnership manner, reduce interest rates of the loans and we will drill down to the Earth core”. As we understand complex challenges do not have simple solutions. Actually, all acute issues of the industry, that the colleagues have been speaking about for many years, did not disappear. The payment period for completed jobs still leave much to be desired, banks are still reluctant to lend money to the Russian oilfield service companies arguing that the liquidity of pledged equipment is not sufficient. Serious deficit of working capital, investment resources, cash shortage did not disappear. The solution of problems in the form of administrative directives to pay quickly, preferential loans, incentives for domestic equipment manufacturers, etc. will not result in the fundamental advance of the industry. It seems to me that any measures for industry development should have a synergy and multiplicative effect for the country economy in general. The investments and industry support measures should produce effect primarily for the domestic market, bring to a new level not only oilfield service companies but also the Russian manufacturers of associated equipment, and R&D institutions. If investments are mechanically injected in the industry by monetary and nonmonetary methods, the foreign manufacturers of high tech equipment will respond quicker than domestic manufacturers. Process-oriented upgrade will be reduced to purchase of relevant equipment and materials outside of Russia which will finally destroy our manufacturers and related segment of applied science.
— Why is this a concern for you?
— Believe me it is not a simple patriotism in the logic of “let’s have a gramophone even made from cast iron as long as it’s ours”, but rather the understanding that the domestic market has its limits and logical development path of any high tech business consists in international expansion. It is not possible to work in the international markets without Russian developed technology and manufacturing base. For example, the company reached its development peak in the domestic market and seeks for routes for exporting its services abroad. I intentionally do not take into account high risk projects in exotic jurisdictions. Let’s consider the Middle East market. It is high premium and rather mature at the same time. Any new player there immediately gets into an unknown system of a customer coordinates with registers of certified suppliers and subcontractors with very few Russian companies among them. The suppliers from the register have been working with your direct competitors in the market for dozens of years. In this situation the principle “old friend is better than two new ones” applies which instantaneously makes you uncompetitive.
It is necessary to work hard to ensure that the Russian oilfield service companies would feel at home in any market. This requires a Russian scientific and manufacturing base with worldwide certified products and services. Our oil companies have long ago crossed the national borders, they are present almost in all continents, participate in oil and gas production projects, acquire refining companies, gas stations, oil loading terminals, but has anyone ever heard about large-scale international projects of Russian oilfield service companies?! You will agree that this is a strange situation. Western oil companies when expanding in the international markets bring their traditional oilfield service and construction contractors. Meanwhile our oilers in their international projects almost completely depend on the oilfield service, construction and manufacturing infrastructure of goods, works and services developed by their western competitors for themselves. This is a very powerful infrastructure and very few people recognize its scale. The network of over 800 American military bases all over the world exists also because Fluor builds them, Halliburton provides catering and fuelling services for them, DuPont provides them with clothes and shoes fit to the climate.
— How does your company feel in the current market situation?
— We are developing. In the last three years we multiplied our production indicators and company revenue. We are continuously working on improvement of the company efficiency and achieve good results. Our drilling unit Naftagaz-Drilling in 2017 was among top 5 independent Russian drilling contractors. If last year we drilled the first million meters since the establishment of our company including 600,000 meters drilled in 2017 while, this year we intend to break last year’s record if the gained pace is maintained. In the first half of 2018 we drilled already 278,000 meters which is 7.5% higher than for the same period in 2017. We have also increased the number of completed wells by 10%. Within 6 months we have constructed 73 wells most of which are horizontal. We are not only seeking to increase extensively the number of orders but we rather want to provide process complicated and innovative services. In average the share of horizontal drilling in the market currently is approximately 40% while in among our wells this share is approximately 70%. We do not limit ourselves. We drill process complicated and underbalanced wells.
— Experts speak about general ageing of drilling rig fleet and increase of requirements for drilling rigs due to development of fields with deeper production formations. Do you agree with this statement? What is the condition of Naftagaz drilling rig fleet?
— I agree. The overall condition of drilling rigs in our country does not fully meet modern requirements. The majority of companies, especially small ones, operate obsolete and worn out equipment. But if you carefully look at the market, you can see that despite the problems mentioned above the industry has very good perspectives. Drilling market in Russia will grow at any oil price. We are actively preparing ourselves for this, purchasing new equipment. Last year we commissioned four new drill rigs and we continue to invest in technical upgrading. Before the end of 2020 we plan to complete full modernization of the equipment fleet and bring the average age of the drilling rigs to 5 years. For this purpose we spent 3.7 billion RUB in 2015-2017. The amount of investments increases. More than 2.6 billion RUB of this amount was spent last year. Our leasing partners help us to implement our plans. In April at Saint-Petersburg International Economic Forum we signed an agreement with VTB Leasing on the intention to finance drilling equipment upgrade and modernization program for the amount of 5 billion RUB. We cooperate with Sberbank Leasing in implementation of our transport and special purpose vehicles program. We challenge ourselves to achieve one million meters per year by 2020 and in five years we plan to become one of the three largest independent oilfield service companies in Russia.
— Currently they speak a lot about automation of operations. What are things going in NaftaGaz?
— In general we are actively working on management of business efficiency. Automation in this case is one of the tools for achieving it. We try to meet present day requirements. Currently, we have already implemented the business performance management system based on Oracle EPM. We introduce the drilling management system which is is being implemented based on the global leading software that manages a well life cycle from geology to operation, automates different sites from operation time recording and equipment repair scheduling to automation of HSE services. Currently the project is in its final stage. We have accumulated a lot of data during the years of using the program. This helps us to generate very accurate forecasts as needed.
The company becomes more transparent for potential investors and other stakeholders because we released consolidated financial statement for year 2017. This is the first IFRS statement and it has received an unqualified opinion from PKF in Russia (editor’s note - PKF International chain, MEF Audit)
— Islam, thank you for the interview.
And thank you. I would like to take this opportunity and congratulate my colleagues on the Day of Workers in Oil and Gas Industry. I wish you new victories in work and “easy prey”!