By Irina Lakaeva

Projects and opportunities

The Russian oil and gas industry is a strategic sector of the Russian economy and accounts for 61% of Russian exports. The industry has demonstrated strong performance in the last several months and is concentrated on about a dozen development projects.

Major transport projects and refining upgrades are expected to result in significant sales opportunities for U.S. equipment and services suppliers, including oil and gas equipment, design, engineering, surveying, service equipment, heavy and light construction, transportation, catering, housing, shipping, medical suppliers, and other products.

Market overview

The latest Russia Oil & Gas Report from Business Monitor International forecasts that the country will account for 50.74% of Central and Eastern European (CEE) regional oil demand by 2012, while providing 70.99% of supply. CEE regional oil demand rose to an estimated 5.46 million barrels per day (b/d) in 2007 and should average 5.61mn b/d in 2008, before reaching 6.25 million b/d by 2012. Production of an estimated 12.74 million b/d in 2007 is forecast to reach 15.3 million b/d by 2012. CEE gas consumption in 2007 was an estimated 632bn cubic metres (bcm), with demand of 772bcm targeted for 2012. Production in 2007 of an estimated 802bcm should reach 961bcm by the end of the period. Russia’s estimated share of gas consumption in 2007 was 69.71%, while its share of production was 80.36%. By 2012, Russia’s share of demand is forecast to be 66.15%, with the country accounting for 73.96% of supply.

Recent mergers and acquisitions by industry giants Gazprom, Rosneft, and Lukoil indicate that the industry is consolidating and maturing, and is emerging as the driver of growth within the energy sector in terms of operation, service, equipment, and technology.

The following Russian companies posted the highest oil and gas condensate extraction volumes: Rosneft, Lukoil, TNK-BP, Surgutneftegaz, and Gazprom Neft. Among foreign players operating in the market, Chevron, ExxonMobil, ConocoPhillips, Hydro, and Sibir Energy enjoyed the largest growth.

Major trends in the Russian oil and gas market include the following:

Consolidation: Where 20 different companies might have been operating on the market in 2000, today one might find no more than 6-8. In other words, the market has become more structured and stable with fewer and larger players.

Increasing activity of domestic companies and their strengthening positions: Domestic companies currently command more than 70% of the market, and their share continues to grow. While most activity is taking place in western Siberia, Sakhalin distributors have begun to show the desire and incentive to put resources into other regions for more modest projects.

High depreciation of fixed assets: Depreciation exceeded 60% in January 2007. The figure for the main gas pipelines stood at 59%, for compressor stations, 90%, and for other equipment, 62%.

Growth of gas export contracts: Export prices are resulting in accelerated construction of pipelines rather than in the modernization of fixed assets.

At present, this sector incorporates more than 15 000 enterprises in Russia. Locally– produced oil and gas equipment enjoys a price advantage, particularly in transportation and pipeline segments, although the technology is often old and the manufacturing facilities are outdated. However, competition among importers has also intensified, as evidenced by an increase in the number of tenders.

U.S. equipment, technological solutions, and products for the industry are recognized for their excellent quality and after-sales service. Oil and gas field machinery, oil recovery, exploration, and field-management services are expected to remain in first place for U.S. exports to Russia.

The oilfield services market experienced a major boost in 2006, rising to USD 12 billion. Growing demand has been reported for work-over, rehabilitation/reconditioning equipment/services, as well as drilling and well tools and products. The largest oilfield services companies operating in Russia include Integra, Baker Hughes, Bentec GmbH Drilling and Oilfield Systems, Parker Drilling, PetroAlliance, Schlumberger Oilfield Services, Halliburton, M-I Swaco, BJ Services, Weatherford, and Pride International.

Projects

Industry experts anticipate that major oil and gas development projects in the Yamal Peninsula, multiple Sakhalin projects, and Timan-Pechora areas in western Siberia, as well as Arctic shelf exploration, will catalyze technological upgrades in addition to construction, infrastructure-building, and other services for oil and gas field development on a large scale. Russia has the longest sea shelf in the world and about 85% of it is located in the Arctic region. According to the government program for oil and gas offshore development, gas supplies should reach more than 170 billion cubic meters and more than 10 million tons of oil annually by 2030. The main greenfields are in the Barents Sea, as well as in the Obskaya and Tazovskaya offshore zones.

Major oil and gas projects in Russia:

1. Sakhalin –1

2. Sakhalin –2

3. Timan-Pechora – Lukoil/ConocoPhilips

4. Shtokman gas fields – Gazprom

5. Yamal peninsula – Gazprom

6. Nord Stream – Gazprom

7. Caspian Pipeline Consortium – Chevron, Lukoil, and others

8. Kharyaga (Nenets autonomy region) – Total, Norsk Hydro

9. Vankor oil and gas field – Rosneft

10. Priobsky oilfield – Rosneft

11. Khanty-Mansijsk oilfields – Rosneft

12. Kovykta gas field (east Siberia) – Gazprom, TNK-BP

According to industry experts and numerous news reports, gas production in Russia should grow to 742-754 billion cubic meters by 2015. The bulk of the increase is expected in Northwest Russia (up 38 billion cubic meters) due to the development of Shtokman offshore deposit in the Barents Sea and in East Siberia (up 33 billion cubic meters) as a result of the exploration of the Kovykta deposit in the Irkutsk region. Russia is moving ahead on prospective new gas export routes to Europe, particularly for LNG.

In 2006, Gazprom said it would move forward with its own gas field development. The state gas monopoly is actively attracting foreign partners to its USD 20 billion project.

According to the FC-Novosti Information Agency, by 2015, gas exports may reach 274-281 billion cubic meters compared to 207 billion cubic meters in 2005, with export-oriented gas production growing at a rapid pace. As much as 30 billion cubic meters of gas will be delivered to China annually along a new Trans-Altai pipeline. Gas deliveries to Europe will grow from 154 billion cubic meters to 175 billion cubic meters, with due account for supplies along Nord Stream and the prolongation of the Blue Stream pipeline to Italy and Central Europe. Russian gas exports to the former Soviet republics will be gradually replaced with Central Asian gas, which has been historically cheaper than the Russian product. The share of the former Soviet republics in Russia’s gas export will go down to 6%.

Other recent developments include the construction of the East Siberia – Pacific Ocean (ESPO) oil pipeline (Taishet – Ust-Kut – Talakan – Aldan – Skovorodino). Transneft, a state-owned oil transportation company, is taking a lead on it. Earlier, the then-Russian President Vladimir Putin insisted that the route should be moved away from Lake Baikal. This made the pipeline 20% longer. Currently, the projected cost of the pipeline, taking into account route changes, inflation, and growing prices of pipe and construction materials, is USD 13.1 billion.

However, according to preliminary estimates Russia’s exports will increase by some 30%, reaching the level of both the Japanese and Korean markets.

Oil deliveries along ESPO may reach 7 million tons a year to the Komsomolsk refinery and 5 million tons to Khabarovsk. A new refinery with an annual capacity of 10-20 million tons is being designed for the ultimate destination of ESPO. It is estimated that the final stage of the project will be commissioned in 2015-2017.

Refineries

High oil export duties lead companies to refine more oil and sell fuel to the domestic market and export more products with lower export duties. To meet the growing demand for fuel and other oil products in the Russian Northwest, Surgutneftegaz is planning to build a USD 6 billion refinery in the Leningrad region by 2011, according to The Moscow Times. The new plant, Kirishi-2, will be able to process 12 million tons of oil a year, which will boost the company’s refining capacity by 50%. Surgutneftegaz will invest at least USD 2.8 billion to build a catalytic cracking unit in 2009 to produce more light products at Kirishinefteorgsintez.

Tatneft, one of the biggest Russian oil producers will build the USD 5 billion refinery in Nizhnekamsk by 2009. The company has contracted Fluor Corporation to implement the project. Other oil producers including Lukoil, Rosneft, and TNK-BP are also upgrading refineries to raise the quality of shipments to European standards as the country’s crude-export taxes make sales of refined products more attractive.

Russian projects to upgrade refineries in 2005-2010 (millions of USD):

Lukoil

Permnefteorgsintez – USD 139

Volgogradneftepererabotka – USD 302

Nizhegorodnefteorgsintez – USD 375

TNK-BP

Ryazanksy refinery plant – USD 407

Saratovsky refinery plant – USD 54

Slavneft

Yaroslavsky refinery plant – USD 211

Rosneft

Komsomolsky refinery plant – USD 727

Tuapse refinery plant – USD 784

TAIF

Nizhnekamsky refinery plant – USD 550

Best prospects

The best prospects for U.S. equipment and services are oil recovery, well optimization, horizontal drilling, hydro-fracturing equipment and services, offshore development technologies and equipment, work-over, rehabilitation/reconditioning equipment/services as well as drilling and well tools and products, and idle well re-commissioning services. The most lucrative prospects for U.S. equipment exports are for greenfield and transportation projects. The market for brownfields is also generally good, although more price sensitive.

Market entry

Russia has a wide network of highly qualified oil and gas equipment distributors ranging from very large broad-liners and those with large dealer networks to the small highly specialized resellers. Most U.S. products are sold through this channel. In addition, a number of U.S. companies have their own subsidiaries and well-established distribution networks throughout the country. Russian distributors tend to believe that it is not always cost-effective for a manufacturer to maintain a representative office in Russia, until sales volumes become substantial. Leading U.S. companies, such as Halliburton, Schlumberger, JB Services, M-I Swaco, Parker Drilling, Baker Hughes, as well as other foreign players from Germany, Norway, and France, are well represented in the Russian market, and their products are available either directly or through representatives or distributors.

Recently, additional channels have become available, such as independent sales agents and e-commerce services. Some oil and gas equipment distributors have been in existence for more than 20 years. They have substantial experience and have developed extensive business connections, putting them in a position to service the needs of U.S. exporters. They will also be able to provide a thorough analysis of sale possibilities and evaluate products against their competitors in terms of both price and quality.

The U.S. Department of Commerce recommends that the Russian market for oil and gas equipment be approached with a recognition of the difficulties that can be encountered, but also with an appreciation for the significant sales potential. Russia’s unclear, often parallel lines of governmental and commercial authority, convoluted management-shareholder relations, selectively– and sporadically-enforced commercial legislation, and instances of corruption make this a difficult market. To succeed in this challenging business environment, a company should cultivate strong connections with Russian industry and with other Western companies that have complementary interests; maintain a physical company presence in Russia; enter the market with a long-term strategy; exercise thorough due diligence, and be persistent.

Another way for American companies to participate in the market is by partnering with Russian design and engineering firms, which still have limited ability to exercise strict quality-control over manufacturers. Flexibility in approaching project development is important, and companies need to adapt rapidly and often cooperate with other firms.

Market issues

There are very few trade barriers to the marketing and sale of oil and gas equipment in Russia. Although it is the importer who pays the duties, levies, and taxes, it ultimately is factored into the final sales price. As such, it is an important factor, which determines the competitiveness of the exporter.

Russia’s tariff system is based on F.O.B. prices. The customs duty rate on imported business equipment into Russia is 10-15%. To this duty an additional 18% “import VAT” is charged. Importers must obtain certificates showing that their products meet Russian standards. Few U.S. exporters experience problems in obtaining certification, but the process can take time and involve additional expenses. Compliance-testing is typically performed at commercially-operated testing stations in Russia or abroad, and the results passed to GosStandart of Russia (State Agency of the Russian Federation for Standardization and Metrology) that issues the certificate. Information on these procedures can be obtained from the importer or from the U.S. and Foreign Commercial Service in Moscow.