Russia ogles Europe’s oil refineries

Graham Stack for Russia Profile (October 5)

 

It’s official Russian policy to push oil companies to acquire downstream assets outside of Russia, and with a wave of M&A set to sweep European refineries, opportunities are looming. But European governments are not enthusiastic – and neither are many Russian companies.

 

Igor Sechin, chief “silovik” in former president Vladimir Putin’s Kremlin, now deputy prime minister for the energy sector in Putin’s government, revealed his dream to the Wall Street Journal earlier this year – a rather modest plan for the man who is believed to have masterminded the dismantling of Mikhail Khodorkovsky’s Yukos. “My dream is for Russian oil to be refined in Russia or by assets controlled by Russian companies,” he confided.

 

Sechin’s plan might be close to realization, as analysts agree the European oil product market is facing a wave of M&A. According to Jürgen Doetsch, co-owner of German oil trader Erich Doetsch, “the European downstream market is facing a structural shift,” as margins shrink due to falling demand and rising oil prices. “The golden decade when refineries in Europe earned big money is ending, and refineries could return to being loss-makers as they were for 25 years before the turn of the century,” says Doetsch.

 

The shift is marked by big 6 supermajors such as British-Dutch Shell, French Total S.A and U.S. ConocoPhilips divesting or mulling divesting refineries. Shell is looking to sell one UK and two north German refineries, and ConocoPhilips uncertain about the future of its Wilmershaven refinery in Germany.

 

Total S.A CEO Christophe de Margerie specified September 22 that Russian companies could be among the buyers: “they have a market to develop in Europe and may be interested to buy when we are interested to sell,” he told  Bloomberg. His statement followed hot on the heels of Total’s sale of a 45 percent stake in its Dutch Vlissingen refinery to Russia’s Lukoil in June for $725 million.

 

The selling is not just limited to the multinationals. Polish petrochemical national champion PKN Orlen, owner of Europe’s largest chain of filling stations, is said to be looking to divest a 63% stake in strategically significant Czech Unipetrol and an 87% stake in Lithuania’s Mazeikiu Nafta, in order to pay down $3.2bn worth of debt.

 

Governments are also getting in on the act. Specifically, Belarus government is mulling privatization of its strategically significant Naftan-Polymir refinery complex, the country’s largest, supplied by the Druzhba pipeline. Belarus has been in talks with Russian majors Rosneft and Lukoil over a sale, but is dragging its heels. “If you have money and willingness, then please come. I am ready to support the programme of privatizing the Belarusian oil refining association,” Alexander Lukashenko said September 16, evaluating the total complex at nearly $3bn.

 

Another dark horse is Venezuelan president Hugo Chaves and the Venezuelan national oil company PDVSA. PDVSA owns stakes in a number of German refineries as partner in a joint venture with BP, Ruhr Oel that controls around a quarter of German refinery capacity. Ever since coming to power in 1999, Chavez has said he will divest PDVSA’s overseas assets and in 2003 PDVSA was in talks to sell to Russia’s Alfa Group, co-owner of oil company TNK-BP, but these talks came to nothing.

 

September, however, also saw the signing of an upstream tie-up between a consortium of Russian oil companies and PDVSA to prospect and extract in Venezuala’s Orinoco regions. The partnership could reasonably also entail asset swaps seeing transfer of Venezuela’s downstream stakes in Europe to Russian companies.

 

Pipeline pressure

 

Russian companies however face considerable political resistance to plans to buy into European refineries, especially of strategic significance. Analysts thus expect the ongoing M&A wave to trigger a number of political spats between Russia and individual European countries, and also bring pipeline politics to the fore.

 

Leonid Fedun, vice president of Lukoil, Russia’s second biggest oil company and most active acquirer of foreign assets, complained to the Financial Times in April 2009 that, “some countries in eastern Europe have an extreme level of political antagonism towards Russian investments.” In the same month Russia’s President Dmitry Medvedev complained of “idiotic” fears in Spain of Russian investment in the energy sector.

 

Fedun’s comments come a week after privately-owned Russian oil company Surgutneftegaz Mol in a surprise move acquire 21% in strategically important Hungarian energy group MOL. Hungarian politicians reacted with fury and responded in dramatic fashion: the Hungarian courts allowed MOL to delay registering the new shareholder until poison pills had been adopted in the company’s charter that left decision-making power with the government-backed board of directors at the expense of shareholders.

 

Poland watched the MOL episode with equal consternation. Despite owning only a 27% stake in petrochemical giant Orlen, the government forced through similar poison pill changes to Orlen’s charter in July, “removing all chances of PKN becoming a takeover target in the future,” according to Wood analysts.

 

Such tactics may however cause the Kremlin to up the ante rather than back off. Russia has gained bargaining power vis-a-vis the Central European refining sector supplied by the Druzhba pipeline, following the start of construction in August 2009 of the Baltic Transport System-2. BTS-2 will reroute Russian oil from Druzhba around Belarus to Russia’s new Baltic port of Ust-Luga in Leningrad Region, and thus increase flexibility of export routes. Refiners remember that Lithuanian refinery Mazeikiu has its oil supply shut off by Russian pipeline operator Transneft after it fell to Polish hands instead of Russian in 2007.

 

The East Central European countries for their part put their hopes on the Odesa-Brody pipeline running through Ukraine from the Black Sea, planning to extend it to the Polish refinery of Plock, Orlen’s biggest plant. The pipeline would then ship Azeri oil to Central Europe. However the feasibility of the plan is not yet established, and the pipeline is continues to be used in reverse mode to ship Russian oil to the Black Sea.

 

Reluctant imperialists

 

The weak link in the Kremlin’s strategy could be the Russian oil companies themselves. With the noticeable exception of Lukoil, they have shown little interest in expensive acquisitions in Europe’s downstream sector.

 

Lukoil is open about pursuing downstream expansion, with major acquisitions in Italy in 2008 along with the Dutch acquisition from Total this year. However, Lukoil’s ambitions predate Igor Sechin’s watch over Russia’s energy sector. In fact the fully private company, in which US major ConocoPhilips holds a 20% stake, counts as one of the most free from Kremlin influence. And the company’s strategy of overseas downstream expansion was evident as early as the 1990s, when it purchased a chain of filling stations in the USA.

 

On the other hand, state-owned Rosneft, Russia’s largest oil company, has still to make a large foreign acquisition, and is focused on capital-intensive upstream expansion in the Arctic and Pacific shelf, with little resources left for acquisition abroad. At the most Rosneft might acquire the Belarus refineries. Gazpromneft, the oil division of state-controlled gas giant Gazprom “doesn’t really have the scale for European acquisitions to make much sense,” according to Ron Smith, head of research at Alfa Capital.

 

Surgutnefegaz, the transparency-challenged private oil company named by Igor Sechin “Russia’s best privately-run oil company” would seem the most likely acquirer of European assets. The company is believed to be sitting on a cash pile and potential war chest of $20bn, and in April this year bought 21% of Hungary’s energy company MOL for $1.4bn from Austria’s OMV, causing outrage in Hungary.

 

At the time, however, many commentators believed the move was requested by the Kremlin for political reasons, namely to stymie the Nabucco gas pipeline project in which MOL is a participant, rather than being part of Surgutneftegaz strategy. “They are very tight and unambitious with their massive pile of money, the MOL thing notwithstanding. It would be completely out of character,” according to Smith. In addition, Surgutneftegaz are more focused on downstream investment in Russia, with large investments in the Kirishi refinery in Leningrad Oblast

 

Finally, TNK-BP held talks with PDSVA on acquiring the Venezuelan companies refinery stakes in 2003, but the talks ended without any results. Analysts say TNK-BP is very focused on adding value, and the returns on European refining are not sufficiently compelling. TNK-BP is more focused on Russian downstream, having just overhauled its Ryazan refinery, one of the largest in Russia.

 

This means leaves Lukoil with a clear field in making acquisitions downstream in Europe, as far as governments allow, and, in conjunction with the ConocoPhilips 20% stake, well on its way to becoming a true oil multinational.

Russia and China sign US$25bn loans-for-crude deal

Graham Stack for business new europe (www.businessneweurope.eu)

Rosneft, Transneft, China National Petroleum Corporation (CNPC) and China Development Bank have signed off on a deal for $25bn in loans for the Russian state-owned companies in return for Russian crude oil supplies to China, according to newswires

The agreements were signed in Beijing on Tuesday February 17 at a meeting between Russian Deputy Prime Minister Igor Sechin and Chinese Vice Premier for Energy Wang Qishan.

Following the meeting, Sechin, who is also chairman of the board of Rosneft, said that Russia is expected to export 15 million tonnes per year (301,000 barrels a day) to China over a period of 20 years in exchange for the loans.

“We agreed on supplies of 15 million tonnes of oil every year over a period of 20 years,” Russian Deputy Prime Minister Igor Sechin told state news channel Vesti 24.

The China Development Bank signed the loan agreements with Rosneft and Transneft. Rosneft and CNPC signed documents on Russian oil deliveries to China for a 20-year period.

Transneft Vice-President Mikhail Barkov told Reuters his company would receive $10bn of the loan and Rosneft the other $15 billion.

“The maturity is around 20 years and this credit is linked to supplies,” Barkov told Reuters. “It is a historic event and the start of a big journey.”

China agreed to reduce the annual interest rate by one percentage point to 6 percent, RIA reported. Vedomosti speculates that the interest rate for the loan is 5.5-6% annually.

The deputy premier also signed a second deal on construction of a branch of the Eastern Siberia-Pacific Ocean pipeline (ESPO) to the Chinese border. CNPC and Transneft signed a corresponding contract on construction and operation of the ESPO branch, according to Prime Tass.
Russia will supply 30 million tonnes through the pipeline link to China when it reaches full capacity, a Transneft spokesman told Prime Tass.

VTB Capital’s Lev Snyvkov writes, “Rosneft could resolve its debt repayment issues without the Chinese loan, but it could be more expensive and problematic given the current tight liquidity conditions. We estimate Rosneft’s net debt at the end of 2008 at about USD 24bn, with USD 8.5bn to be repaid in 2009. The company’s 1Q09 repayments (USD 0.9bn) were covered by operating cash flow, while the 2Q09 repayments (USD 4.1bn) have already been agreed with banks (refinancing). In 2H09, Rosneft needs to repay USD 3.5bn.

The pricing parameters of crude supplies (as yet unknown) are important for assessing the true cost of the loan. The news is in line with what was announced earlier but is still marginally positive for Rosneft and Transneft as the agreement is an additional source of liquidity in the tight liquidity conditions on the market.”

UralSib’s Viktor Mishnyakov writes, “we believe the loans received might provide an impetus to massive development of Eastern Siberia. Assuming the government will exempt the East Siberian fields from export duty, the biggest winners will be Rosneft (which has the most projects in Eastern Siberia), TNKBP, Surgutneftegas, Slavneft and Gazprom Neft. Regional development would also likely trigger the extensive use of independent oil field services in the region, with Integra benefiting the most.” We think China might receive certain benefits in return. We believe that two options are possible: greater access to the East Siberian fields (currently two upstream projects via a JV with Rosneft) and the potential transformation of ESPO into a joint stock company, with China getting 49% or 50% control in it.”

Russia gets a head start in the Arctic race

Graham Stack for Russia Profile

Despite media hysteria about alleged conflicts looming over Arctic resources, most experts say Russia is playing a constructive role.

Russia’s planting of a titanium flag on the seabed at the North Pole last summer was one of the media eventsof 2007. In combination with soaring energy prices and melting Arctic ice, the images sparked sometimes wildly speculative panic-mongering about the “coming Arctic war.”

In fact, the hype around the flagplanting was little more than an election campaign gag for the pro-Putin United Russia party – the United Russia flag was one of the items deposited on the seabed in a time capsule, and expedition leader, famous explorer Artur Chilingarov is a United Russia deputy.

But there was a scientific purpose to the expedition as well: to gather seabed samples. They were required to support of Russia’s claim that the submarine Lomonosov ridge running through the Central Arctic is an extension of Russia’s continental shelf.

Russia is filing its claim in the framework of the United Nations Convention on the Law of the Sea (UNCLOS). UNCLOS allows countries to expand their maritime Exclusive Economic Zones (EEZ) beyond the current 200 nautical miles from the coastline up to a maximum of 350nm, in the case that their continental shelf extends so far out to sea. A country has sole rights to exploit mineral deposits located in its EEZ.

And for a country like Russia that positions itself globally as an all-round energy supplier to Europe and beyond, the Arctic’s oil and gas resources constitute not just a source of extra income, but crucial to the Kremlin’s plan of building Russian energy companies into global majors.

This might be a source of friction were Arctic resources tantalisingly outside of Russia’s reach. But in fact the lion’s share of Arctic hydrocarbons seem to be located in recognized Russian waters. Making Russia the least likely country to launch aggression to change boundaries.

A tale of two studies

July 23, 2008, saw the prestigious United States Geological Survey (USGS) publish its widely awaited official analysis of the oil and gas riches of the Arctic. The document is destined to become a key reference point for US policy in the area.

The USGS study trumpeted that the Arctic “may constitute the geographically largest unexplored prospective area for petroleum remaining on Earth.” According to the survey, Arctic resources account for about 22 percent of the undiscovered, technically recoverable resources in the world: about 13 percent of the undiscovered oil, 30 percent of the undiscovered natural gas, and 20 percent of the undiscovered natural gas liquids in the world.

The USGS survey, however, ignores the very different findings of a Wood Mackenzie survey published November 2006. Wood MacKenzie’s study found that the Arctic only contained 3% of the world’s recoverable hydrocarbon reserves. “The Wood Mackenzie is proprietary and we haven’t bought it,” laconically explains the leader of the USGS Arctic team, Don Gautier.

In stark contrast to USGS’s enthusiam, Wood Mackenzie’s lead author, Andrew Latham, commented, “our assessment basically calls into question the long-considered view that the Arctic represents one of the last great oil and gas frontiers and a strategic energy supply cache for the US.”

Without entering into details of methodology, the huge discrepancy between these figures shows just how much remains basically guesswork. And memories of the hyperbole about Caspian Sea resources in the 1990s should incline observers to prefer the more conservative estimates.

But just as significant as their contradictions on quantity, are the studies shared findings on the quality of the Arctic’s hydrocarbons.

Firstly, both studies agree that the Arctic’s hydrocarbon resources consist predominantly of natural gas. ‘Arctic resources are gas-prone with around three times more gas than oil,’ according to USGS’s Don Gautier. According to Wood Mackenzie, 85% of the discovered resource and 74% of the exploration potential is gas.

The second shared finding is that, according to Gautier, while 84% of the undiscovered oil and gas is indeed offshore, most of it “lies within national boundaries as currently defined.” This means the UNCLOS rules on extending those boundaries are in fact of secondary importance.

Thirdly, and crucially, most of the gas is in the Russian sector. “The West Siberian basin in outstanding for gas,” is one of USGS’s main conclusions, and the East Barents Sea is also ranked excellent. Around 60% of total Arctic gas lies squarely in the Russian EEZ.

So it seems Russia has already won the ‘coming Arctic war’ without a shot being fired.

UNCLOS is no cause for alarm
But this still leaves around 30% of Arctic resources lying more than 200 nautical miles offshore. UNCLOS, and it’s expert Commission on the Limits of the Continental Shelf (CLCS) will decide who can claim jurisdictions over these areas.

This is where Russia’s controversial claim to the North Pole, i.e. the Lomonosov ridge, comes in.

Russia’s claim to the Lomonosov ridge is indeed disputed by Canada and Denmark – but purely within the legal framework of UNCLOS. All three countries have voluntarily signed up to accept its findings, and no party has ever said they might not do so.

The crucial point is that all signatory states have committed themselves to UNCLOS precisely as a non-conflictual, impartial means of resolving questions of marine jurisdiction. Only the US refuses to sign – because of the impingement of sovereignty this involves.

“Rights to the resources of the continental shelf beyond 200nm have been enshrined in international law since at least 1994, when UNCLOS entered into force and so far all of the Arctic states have followed the procedures established under UNCLOS for claiming those rights,” says Martin Pratt, head of research at Durham University’s International Boundaries Research Unit (IBRU). IBRU published the definitive map of Arctic boundaries August 5, 2008.

According to Pratt, “all the available evidence still points to a peaceful division of the Arctic.”

“The conflict potential is inflated mainly because people find it exciting to talk and write about, and perhaps also to some extent because some people miss the cold war,” argues Indra Øverland, Head of the Energy Program at the Norwegian Institute of International Affairs (NUPI). “There are in fact not more territorial disagreements in the Arctic than in most other parts of the world. Such disagreements are a normal part of inter-state relations.

The perceived ‘race for the Arctic,’ according to Øverland, is merely a reflection of a UN ruling that a country has 10 years to make claims beyond the 200-mile zone.

Since Russia was one of the first to sign up, in 1997, it is compelled to get a move on in filing its claims.

“Russia does play by the rules laid down in UNCLOS, and agrees with the other Arctic nations that this convention is the basis for future developments in the region,” says Alf Håkon Hoel, head of the politics department at the University of Tromsø in the Norwegian Arctic.

“But that doesn’t mean that the Arctic coastal states aren’t keen to secure rights to exploit resources in such areas in the future,” counters Pratt.

“That is the process in which Russia is currently engaged with the Commission on the Limits of the Continental Shelf,” he continues, “and once the outer limit of the Russian continental shelf has been defined, it won’t be able to claim sovereign rights over any other areas of Arctic seabed.”

However, the idea that signatories to a UN convention regulating maritime jurisdiction would then come to blows over its findings, is as absurd as suggesting war could break out between Germany and Poland over voting rights in the European Commission.

Moreover, the timescale of the division and exploitation of the Arctic is likely to stretch decades into the future, with the UN’s Commission on the Limits of the Continental Shelf (CLCS) not due to complete its work till 2020.

And only when all disputes have been solved, will it be possible to commit the massive investment and start the pioneering work needed to get at oil and gas lying far offshore.

“Referring to the extension of the continental shelf beyond 200 miles, I would say that possible resources in this area will only be relevant in a much longer time perspective, for technical and economic reasons,” argues Arild Moe of Norway’s Fridtjof Nansen Institute.

“There is no imminent conflict over resources there, of which we know little and about which the most recent USGS study is not particularly optimistic,” says Moe.

Technology, not territory, is the key to the Arctic

The barrier Russia and other countries face in accessing Arctic resources is not connected with maritime jurisdiction, but with technology.

The most ambitious current Arctic project underway is Gazprom’s giant Shtokman field in the Barents Sea. With 3.8 trillion cubic meter of natural gas and more than 37 million tons of gas condensate, the field contains enough gas to fuel Europe for seven years.

But the question is how to get it. The field is 550km off shore from the port of Teriberka, 4000m beneath the seabed. Further hazards include icebergs, drift ice, sub-zero temperatures polar nights, megawaves and an uneven seabed. Quite simply, nothing like this has ever been attempted.

“Nobody has yet attempted multi-phase gas flow transportation over such a distance, and that’s the main technical and technological problem today,” Alexander Selin,an official at Shtokman license holder Sevmorneftegaz, told Interfax at the end of July.

According to Konstantin Batunin of Moscow’s Alfa Bank, not even Gazprom knows yet what technology will be used. Russia’s gas giant has enlisted the help of Norway’s Statoil and France’s Total as junior technology partners, and this international collaboration to pool expertise is another sign of how the Arctic is likely to produce new partnerships rather than fuel rivalries.

Oil and gas development and the opening of the Arctic to shipping due to global warming – the summer of 2008 showed the lowest icelevel since records began  also mean that new shipping technologies are needed to master the Arctic waters.

And here as well Russia is kitting up.

In 2007, Russia started the merger of all state-owned shipping and ship-building assets into two giant holding companies

Sovkomflot-Novoship, now the world’s fifth largest shipping company, and the United Ship-building corporation. Both of these companies are under orders to focus on energy shipping in general, and ice-class vessels in particular.

And March 25, 2008, a state-linked investment company FLC bought a 70% stake in three German shipyards belonging to Norway’s Aker group – shipyards specialized in building dual-action ice-class ships, the stern of which doubles up as an ice-breaking bow.

Finally, August 27, 2008, Russia’s seven nuclear-powered icebreakers were transferred from the trusteeship of a private shipping company and transformed into a state enterprise – Atomflot, part of the newly-formed nuclear power state corporation.

So regarding Russia’s North Pole flag-planting stunt of 2007, the medium was the message: Russia displayed it had the bathyscape technology to conduct Arctic seabed operations.

But much of the Western media preferred to believe that Russia’s flag planting was an aggressive assertion of rule over the North Pole – and conspiracy theorists even perceived a Kremlin masterplan to seize control of Christmas.

Those conspiracy theorists will see their fears confirmed with Chilingarov s next bathyscape dive: as announced end of July, he intends to dive to the bottom of the Mariana Trench, the deepest part of in the world’s oceans. The Mariana Trench is in the middle of the South Pacific – surely indicating a Kremlin claim to Easter Island.

Oil field services: The market’s answer to Russia’s stalling oil production

With Russian oil production beginning to fall, the new and growing Russian oil field service (OFS) sector (specializing in oil exploration and production services, solutions, and technology) could hold the key to turning this trend around — by cutting costs, increasing competition, and introducing new technologies.

Russian oil production in April of 2008, at 9.72 million barrels, was 1.8 percent below the production peak in October, despite world oil prices having soared to $126 per barrel (compared with $12 ten years ago).

In an interview with Smart Money, Vagit Alekperov, CEO and largest shareholder of LUKoil, Russia’s second largest oil company, called the drop in production “a trend.” His colleague, LUKoil CFO Leonid Fedun went even further, telling the Financial Times on April 15th that last year’s 10 million barrels per day peak was the “highest he would see in his lifetime.” The Russian government has been swift to respond with the promise of tax cuts to stimulate new production.

But another market-driven development will also be crucial to kick starting production growth: the ongoing emergence of an independent oilfield service sector in Russia.

Emerging from the shadow of oil majors

Global market leaders in oilfield services, such as Schlumberger and especially Halliburton, are household names, not least due to the latter’s controversial role in Iraq and links to U.S. Vice President Dick Cheney. Although what OFS companies sell are technologies for extracting oil, and not the oil itself, they constitute a trillion-dollar business. Schlumberger, the market leader, has a capitalization of $110 billion, a turnover of $23.28 billion, 80,000 employees worldwide, and holds 8.9 percent of the Russian market.

Characteristic of Russia’s capitalist energy field, only in the last three years have Russian OFS companies crystallized as a sector independent of integrated oil companies, mostly by spinning off from the latter. In 2008, the process is snowballing. The global practice is for oilfield services to be independent of oil companies, but the Soviet industrial legacy means that in Russia, over 50 percent of the market is still dominated by in-house services, not directly exposed to competition or shareholder scrutiny. Yet this is set to change and competition to increase.

“In the West, very few oil companies have their own oilfield service departments. You only find this in Russia and in China,” Andrew Gould, the president of Schlumberger, told the Vedomosti business daily on April 23rd. Gould added that the current trend for spinning off oilfield services is “excellent for competition,” and spoke highly of Russian technological expertise–Schlumberger itself employs 15,000 Russians worldwide, constituting almost 20 percent of its workforce.

“Oil companies are going to keep spinning off their non-core assets,” said Aleksandr Dzhaparidze, president and owner of Eurasia Drilling, also interviewed by Vedomosti in January. Eurasia Drilling and Schlumberger both possess just under nine percent of the market share in Russia.

Eurasia Drilling was formerly “LUKoil Burenie,” the OFS division of the LUKoil oil giant. Now it is the largest Russian OFS company, with market capitalization of $3.4 billion, having raised $450 million through an IPO in November of 2007.

Russia’s largest oil company, the state-owned Rosneft, also confirmed its plans to float its three OFS divisions following fundamental restructuring: the restructuring of Rosneft Service, uniting all regional service subsidiaries, was completed in April. Rosneft Service along with RN Drilling and RN Energy IPOs are slated for 2010-211.

TNK-BP, Russia’s third largest company by output, is also restructuring its 12 OFS units into one division, with the aim of either selling or floating it, or, alternatively, running it as a profit center. The service units earned $500 million in 2007, and Timothy Summers, Chief Operating Officer of TNK-BP, told journalists in April that he expects a profit of $700 million in 2008, along with a market capitalization of about $1-2 billion. The Siberian Services Company (SSK), a former YUKOS OFS arm, currently enjoys a market share of 2.5 percent.

A number of smaller operations are also being set up in the sector. Britain’s Imperial Energy announced early February that it is mulling an IPO of its freshly-consolidated oil services arm Rus Imperial Group (RIG). In March, Russia’s TMK, one of the world’s top three oil and gas pipe producers, announced the launch of the TMK Oilfield Services division.

Other investments in the sector include Geotech, conducting a $100 million private placement to institutional investors in preparation for an IPO in 2010, and in March, the leading Russian OFS company Integra announced a joint venture with America’s Smith International Inc., another global leader.

In contrast to the increasingly restrictive investment environment for foreigners in the oil sector per se, the OFS sector is very much open to foreign competition, which tends to focus on the high-end hi-tech niche. According to Rencap’s Roman Eleagin, this means that within five years, majors will outsource 70 percent of oil services to independent companies, in contrast to the current 50 percent.

Government tax break will further boost OFS

This change in the sector will go hand in hand with a double-digit growth of the OFS market, that will grow from approximately $11.5 billion to $15 billion per year. Driving the coming boom is the challenge posed by oil production, due to field depletion and greenfield development, combined with soaring oil prices. Analysts and executives agree it’s getting harder and costlier to extract oil in Russia.

“One of the most important global trends is the increasing challenge of maintaining the level of oil and gas production,” said Schlumberger’s Gould in March. “This is the fundamental reason behind the rise in costs. The second global trend is to replace reserves by conducting exploration. In Russia, this is being done mostly in Eastern Siberia. But infrastructure there is underdeveloped.”

Oil field services do make a difference, by employing state-of-the-art technologies to get the most out of depleted oil fields and by cost-efficient exploration. “We all know about high global energy prices,” Vladimir Putin said, addressing the Duma as prospective prime minister on May 8th. “Revenues of oil companies are not small. However, we are taking a large chunk of these revenues (about 75-80 percent) into the budget in the form of taxes and export duties. To a large extent, this leads to an increasing number of idle, low-debit wells. Exploration and development of new deposits take place slowly.” Putin concluded that “In order to stimulate production and refining of crude oil, it is now time to make a decision to reduce the tax burden on this sector.”

On Monday May 26th, the first meeting of the new Presidium of the Russian government approved a reduction of the mineral extraction tax (MET), by increasing the non-taxable base rate from $9 per barrel to $15 per barrel. It also approved seven-year-long tax holidays, for developing new regions such as Yamal, Timano-Pechora, and the continental sea shelf (in the Russian Arctic).

This is music to the ears of OFS companies. As analysts at the UralSib investment bank said, Russia’s OFS companies such as Integra, Eurasia Drilling, and C.A.T. oil, are now set to “benefit handsomely from the expected wave of capex growth that integrated companies will pour into exploration and development