Oil and gas companies and Russian equipment manufacturers have, both jointly and individually, long been searching for an answer to the eternal Russian questions “who’s to blame” and “what needs to be done” about the almost critical situation that has emerged in the country’s fuel and energy sector equipment market. The latest conference on the oil and gas industry supply chain (“Neftegazsnab 2012”) showed that it is still hard for equipment manufacturers and consumers to find a common language.

The oil and gas companies lambasted the Russian equipment makers for poor quality equipment, while the latter complained about a lack of state support, non-transparent tenders, especially on the part of state companies, and under-pricing, which is preventing them from developing technologically. Companies are solving their problems in various ways: some are refusing to buy Russian-made equipment, and others are sending their inspectors to factories to control quality. But in general, the situation in Russian oil and gas equipment manufacturing remains difficult, and could get worse with the country’s membership in the World Trade Organization.

The speaker from Gazprom Neft said the sector found it difficult to produce hi-tech equipment. It is plagued by low-quality goods, the lack of discipline, lengthy delivery times, demands for individual certification for non-serial products, and frequent high costs compared with those set by foreign counterparts.

The company blames a lack of skilled workers, poor logistics, the huge pressure on selected enterprises and limited capacity, a lengthy decision-making process, and low employee motivation.

Even so, the company “bets on local manufacturing and Russian-produced goods.”

Mikhail Shulyak, a department head at NOVATEK, said the import-substitution program would not bear fruit unless Russian enterprises became more active, modernized, enhanced quality, and became more competitive.

In many cases, imports are being substituted not with Russian goods but with foreign goods made in Russia, as with the car industry. Nearly all conference delegates backed this up. Yet still, Russian bureaucrats report on the achievements of Russian machine building and the success of import substitution.

Shulyak said he thought the share of Russian manufacturers should be increased but said he was against direct substitution of imported equipment for domestic equipment without taking into account quality and price. Such a replacement would have economic costs, he said.

The only way out of this situation is for the manufacturers themselves to take steps to compete on price and quality with their foreign rivals, he said. Only real competitiveness between Russian companies and foreign manufacturers and a competitive advantage for Russian products will squeeze foreign suppliers out of the Russian market as a result of technological and economic competition. That is real import substitution, Shulyak said.

To achieve this Russia needs a productive dialogue between oil equipment manufacturers, consumers, and designers. The manufacturer should not contact the procurement office but rather the experts that will work directly with the product and can tell the manufacturer what they need because extraction conditions change and become more complex, he said. Domestic manufacturers should be more active in promoting their products because “we may simply not know that we can substitute with a Russian-manufactured product.”

Manufacturers asked companies to tell them what equipment they needed so they could design and produce it. Novatek had several examples of successful cooperation with Russian manufacturers.

How to resolve the quality problem?

Oil companies say one of the main reasons why they do not buy more Russian equipment is its poor quality. TNK-BP Inventory Procurement Director Alexei Kada said the company controls equipment quality directly at the production plants.

In order to ensure the necessary quality for equipment supplied from domestic plants, TNK-BP has built a quality control system in which it sends inspectors directly to the manufacturer. Inspections are carried out if the company starts working with a new supplier for products that are critical for TNK-BP in terms of complexity and necessary quality and completion dates, or if the defect percentage is over a certain amount.

The inspections aim at helping in the production process, identifying and correcting problem areas. The inspection system has been carried out since 2005, Kada said. The company is interested in putting inspections in place at the very outset of cooperation.

TNK-BP has reached agreements with various companies that envisage the manufacturer’s paying for inspections if the defect percentage exceeds a certain threshold.

Defects have been virtually eliminated through this quality control system, and the spending on such inspections is much less than the benefits achieved through them.

State companies vs. private companies

A representative of the Union of Oil & Gas Equipment Producers said in his presentation that the main complaint from local producers has been aimed at “natural monopolies and Rosneft, curiously enough.”

“They say that these companies are buying everything at inflated prices and later, real suppliers fall off from the tender, and this not only affects equipment but also oil services. And then, these major suppliers end up as subcontractors for dummy companies,” he said.

The organization’s spokesman said that complaints against private companies have appeared largely in regards to technological issues and “if it concerns inflated prices, then this concerns either natural monopolies or companies with state interests.” He also said that Gazprom and Rosneft have distanced themselves from our machinery industry. For them, the most important thing is extensive projects, and the kind of equipment used there is a secondary issue. He stressed that “political will” is needed concerning this issue, otherwise “French welding equipment, Japanese pipe-fitting equipment, and so forth will appear in Russia.”

He also cited the example of the Prirazlomnoye field, the customs duties for which have been removed. “The import supplier delivers without having to pay the VAT (tax), while the Kazan Motor Production Union has been forced to pay all taxes. Naturally this will not be competitive,” he said. “Moreover, our enterprises don’t have floating assets, don’t receive loans and state subsidies. Furthermore, this puts them in an uneven position against foreign firms. This is the state’s very indifferent policy in regards to its own enterprises,” the union representative said.

“Machine-building, just like ten years ago, is now in a survival mode,” one of the producers complained, saying that contracts with end customers are a problem.

An employee at Burservis, a producer of drill bits, lamented that relations between suppliers and consumers have collapsed since oil & gas companies have spun off their service division. “The technology remains with the service companies,” while representatives of oil & gas companies do not understand the particularities of production operation. “We can’t get through to them. Quality qualifications are declining,” he said.

“We now see that, in a very technologically saturated sector of the economy, that is the oil & gas sector, where most money is made on the effective application of technology, we are fighting for price indicators,” a Burservis spokesperson said, meaning that fuel and energy companies are currently focused on posting profits. He added that companies do not want to pay high prices for production, while equipment producers have no options for investing in research and development, which would spur on technological developments.

A Slavneft representative urged Russian machine builders not to complain, but rather to work towards reducing costs, a particularly relevant task in view of Russia’s accession to the WTO. Once that happens, Russian machine builders will live through even tougher times.

An employee at Gazprom Neft noted that with respect to some items for the oil refining industry, the domestic producers Volgogradneftemash and Izhora Plants have an enormous workload, and prices are absolutely comparable to their European equivalents. At the same time, he said, these plants are not investing in modernization. “However, I haven’t heard that the FAS fined these two plants for collusion, whereas oil & gas companies were fined for the price of gasoline, pushing to lower costs,” he said.

A representative of Volgogradneftemash, Russia’s largest producer of technical equipment for the oil, gas, and the petrochemicals industries, said that many Russian producers harbor resentment towards oil & gas companies due to the lack of orders and an undervaluation of the price for the products purchased. While he expressed support for the producers, he emphasized that “emotion is a very bad counselor in life.”

“Those who show they are offended will be taken advantage of again and again,” he said. He nevertheless asked oil & gas companies not to understate the price in placing emphasis on maximizing profit. He noted a problem in the qualification of personnel in the industry, but said that “in order to change something, change yourself.”

“Companies are open, believe me. Nobody is obligated to love us,” he said.