The Future of the OFS Market in Russia: RPI
Vadim Kravets
The past year, 2012, was significant for the Russian oilfield services market in light of two trends. On the one hand, the nascent technological breakthrough in service offerings continued full-on: horizontal drilling and related services have become virtually commonplace, while well workover and logging applications have become more sophisticated. On the other hand, the oilfield services market has ultimately become a customer’s market, one that almost completely controls pricing limitations and technological nuances of the work. This radically distinguishes the current competitive landscape from the state in which the oilfield service sector found itself before the 2008 and 2009 financial and economic crisis.
In all likelihood, the oilfield services market will continue in its current state until at least 2014, i.e., until the start of large-scale commercial development of major fields in the Yurubcheno-Tokhoma zone in Evenkia and Messoyakha group of fields in northern Yamal-Nenets autonomous district (YNAD) (see “Russian oil production forecast for 2013-2022”).
Furthermore, it is not at all guaranteed that in two or three years the oilfield service companies will get a significant break, since the acquisition of TNK-BP by Rosneft in late 2012 allowed the state-owned buyer to influence economic behavior of not only its new subsidiary but, indirectly, the policies of Slavneft and Messoyakhaneftegaz, which after the acquisition of TNK-BP it came to co-own, on a parity basis, with Gazprom Neft.
In effect, a powerful alliance comprised of Rosneft, former TNK-BP, Slavneft and Messoyakhaneftegaz had emerged by the end of 2012, and it is this alliance that will control the development of Russia’s largest new fields through 2022 – along with a considerable share of the remaining market.
Market Structure is Already in Place
In order to understand the future direction of the market given this competitive environment, we should take a look at its origins.
The Russian oilfield services market in its current form did not appear overnight. Initially, the pool of major subsoil-user customers was faced off with an amorphous mass of rather disparate provider companies.
By 2007, the structural makeup of the domestic market was largely in place, featuring three distinct categories of companies:
» Major internationals – Schlumberger, Baker Hughes, Weatherford, and Halliburton
» Major Russian oilfield service provider holdings (such as Integra or Geotek)
» Small-size domestic companies
The vast majority of the international companies possess their own equipment manufacturing facilities, service providers and research and engineering centers. Their hallmark has been the provision of expensive services and almost never the sale of their know-how – similar to the way Western companies used to operate back in Soviet times.
The Russian “holdings” typically work in the mid-price range, and the quality of their services is approaching that of their foreign competitors. In the future, they have good chances of eventually catching up with international oilfield service giants in terms of service quality. Some of these companies can be considered affiliates of Russian vertically integrated oil companies (VIOCs). Examples of these include BKE Eurasia (known for its ties to Lukoil) and Bashneft – Service Assets, founded in early 2013 and currently a subsidiary of Bashneft.
Finally, the market is home to a whole lot of small independent companies, which work in the low price range segment. From a technology standpoint, demand for their services will soon be limited to the least economically and technically robust oil companies.
Yet the Market has Grown
It is against this service sector backdrop – and organically with it – that the financial and physical parameters of the Russian oilfield services market have evolved over the past eight to ten years.
The Russian Oilfield Services Market study undertaken by RPI in early 2013 shows that on aggregate the market grew in cash terms from 2005 to 2012 even despite the 2008 and 2009 crisis.
Between 2005 and 2012 the market grew 122 percent from 232.8 billion rubles in 2005 to 516.2 billion rubles in 2012. The primary growth drivers were:
» Production drilling
» Hydraulic fracturing
» Well workovers
To increase oil production, Russian oil companies engaged in extensive drilling campaigns in both new and old fields. For virtually all Russian VIOCs, drilling during this period was the main method of increasing overall hydrocarbons production. Apart form extensive increases in meters drilled, production drilling underwent certain technological improvements (for instance, horizontal drilling became more widely used). This predictably promoted the growth of related oilfield service segments, such as Measuring While Drilling (MWD) and Logging While Drilling (LWD).
The hydraulic fracturing segment grew due to both wider application of this technique in new wells and the desire to use fracturing to boost flow rates in the current declining well stock (i.e., in wells completed before the current calendar year).
The workover sector grew rapidly as well interventions, especially in the ageing well stock, became increasingly costly and frequent.
Consequently, in 2012 the following operations held the highest shares of the total Russian oilfield services market:
» Production drilling (28 percent of the total market in cash terms)
» Well workover (15 percent)
» Pump services (10 percent)
» Well logging (10 percent)
» Hydraulic fracturing (nine percent)
These segments held commanding heights in absolute money terms in 2012:
» Production drilling – 142.8 billion rubles
» Well workover – 77.5 billion rubles
» Pump services – 53.7 billion rubles
» Well logging – 53.4 billion rubles
» Hydraulic fracturing – 44.6 billion rubles
Where we are Now
Moving on to a market assessment in physical terms, we get the following picture. We will note, however, that analysis in this article is limited only to the production drilling, hydraulic fracturing and well workover segments.
Between 2002 and 2012, total production meters drilled grew by 137 percent. More specifically, in the post-crisis period, the increase in the nationwide meters drilled in 2010 by 17.3 percent over the previous year fully made up for its decline in 2009. In 2011 total production meters drilled across Russia increased by a further 8.9 percent compared with 2010, closing in on 18 million meters. This trend continued in 2012: production meters drilled grew by 9.5 percent and reached a ten-year high, having come very close to 20 million tons.
In the production drilling sector, horizontal drilling grew particularly fast from 2010 to 2012 – even though earlier, throughout the 2000s, horizontal drilling was not widely used in Russia, primarily due to engineering constraints, such as a lack of sophisticated MWD and LWD equipment and modern drilling fluids. On average across VIOCs, during this period the share of horizontal drilling stayed within 10 to 12 percent of total production drilling. (Note: This share was calculated as a percentage of horizontal wells in the total number of production wells.)
After 2009, a new trend took shape in horizontal drilling – most Russian VIOCs have either already rapidly increased their proportion of horizontal drilling from 2010 to 2012, or intend to do so over the next few years. As a result, total horizontal drilling nationwide grew by 29 percent in 2010 and by 25 percent in 2011 (year on year). Horizontal meters drilled grew a further 21 percent in 2012.
In the past two or three years Russia has seen extensive application of hydraulic fracturing both in new wells (i.e., wells brought on stream) and in the current declining wells.
According to experts’ estimates, hydraulic fracturing is currently performed on approximately 70 percent of new wells. This is due to the fact that oil companies have to tap into poor-quality reservoirs. At Surgutneftegaz, this number is even higher, reaching nearly 80 percent of the total new well count. According to industry expert estimates, the percentage of new wells in which hydraulic fracturing is performed will increase even more in the future.
In 2009, due to the economic crisis, the number of hydraulic fracturing jobs declined by 6.2 percent compared with the year before. As the crisis ended in 2009 and 2010, hydraulic fracturing started growing again. In 2012 the number of fracturing jobs on new wells increased 43.6 percent compared with 2009.
In 2007 and 2008, the number of successful fracturing jobs performed by Russian VOICs on the declining well stock leveled off at around 4,000 jobs per year. (Note: A successful fracturing job is one that results in an increase in a well’s flow rate.)
In 2009, due to the economic crisis and decline in investment, the annual number of fracturing jobs on the declining well stock slipped 1.3 percent over the previous year. This trend held true for all Russian VIOCs with the exception of Surgutneftegaz.
In the post-crisis period, in 2010, the annual number of hydraulic fracturing operations grew 5.9 percent compared with 2009. For most companies, this growth can be viewed as compensatory. Nevertheless, in 2010 TNK-BP, the leader in the number of fracturing jobs on the declining well stock, cut the number of its jobs by 15 percent compared with the previous year.
The reasons for that were:
» Declined per-unit effectiveness of hydraulic fracturing
» Opportunities for using alternative production maintenance methods (horizontal drilling, sidetracking, and various enhanced oil recovery techniques).
Despite the relative stability of VIOC’s fracturing work scopes, their overall effectiveness declined from 2004 to 2008. The main reasons for this decline were:
» Intensive application of the technique in previous years, which significantly reduced the number of good candidate wells for hydraulic fracturing
» Repeated fracturing in the same wells (which typically does not deliver significant increases in flow rates)
» Limitations of using “heavy” hydraulic fracturing
In 2009 the negative trend in fracturing effectiveness was reversed thanks to a certain improvement in per-well benefits enjoyed by some companies, such as TNK-BP. In 2010 and 2011, the overall nationwide decline in effectiveness continued: during these years this index declined year on year by 8.2 percent and 10 percent, respectively. In 2012 the decline in overall fracturing effectiveness accelerated, dipping to 12.3 percent compared with 2011.
Tatneft succeeded in achieving the highest per-well effectiveness of hydraulic fracturing operations between 2006 and 2009. Since 2006, its target benefits per fracturing job have remained at or above 3,000 tons. For Tatneft, hydraulic fracturing is a key tool for increasing oil production, and the company seeks to maximize its impact.
In 2010 and 2011 the sector faced mixed trends in per-unit benefits, but the variance diminished. At the same time, the average per-unit benefits across Russia continued on a downward trend throughout 2009, 2010 and 2011.
In 2012 a downward trend in per-unit benefits was observed virtually across all VIOCs, except for Gazprom Neft. Consequently, it declined by 16.1 percent nationwide compared with 2011. From 2005 through 2012, the average per-well fracturing effectiveness across Russia dropped 45.0 percent, from 2,724 tons to 1,500 tons per intervention.
The number of workovers across the Russian petroleum sector declined from 2002 to 2004, hitting an all-time low of 29,100 jobs in 2004. On the other hand, immediately before the crisis, between 2005 and 2008, the number of these jobs grew consistently. During this period the total annual number of workovers performed in Russia grew 9.8 percent from 33,000 jobs in 2005 to 35,200 jobs in 2008. This trend was aided by the ageing of the well inventories, which required increasingly frequent interventions.
In 2009 most companies cut the number of their workover jobs compared with 2008. The exception was Surgutneftegaz and Rosneft, which had to resort to workovers to maintain production rates at their ageing fields. These companies spared no effort to maximize the frequency and scope of their workover operations. As a result, Rosneft in 2009 became an absolute leader in the number of completed workover jobs – accounting for 32 percent of all workovers performed by VIOCs. (Surgutneftegaz in 2009 accounted for 17.8 percent of the VIOC jobs).
In 2010 and 2011 the number of completed workovers began rising again virtually across the sector. In part, this growth can be viewed as compensatory. In 2011 the total annual number of workovers performed across Russia grew by 16 percent compared with 2008.
The total number of jobs grew 0.3 percent to 39,600 jobs in 2012 over 2011. But the trends varied across different companies.
The following companies increased their workover scopes relative to 2011:
» Bashneft (by 1.9 percent)
» Lukoil (by 18.9 percent)
» Rosneft (by 4.7 percent)
» Slavneft (by 4.8 percent)
» Surgutneftegaz (by 1.6 percent)
The following companies cut the number of workover jobs:
» Gazprom Neft (by 9.7 percent)
» RussNeft (by 17.0 percent)
» Tatneft (by 8.7 percent)
» TNK-BP (by 14.1 percent)
Between 2002 and 2011, the cost per workover increased in virtually all Russian petroleum companies. As a result, from 2005 through 2011 the average per-job cost nationwide increased by 69 percent from 1.1 million rubles in 2005 to 1.9 million rubles in 2011. The main factors for the rising costs were:
» Increased complexity of workovers due to the ageing of the well stock
» Higher service rates, including due to inflation
The greatest increase (in absolute terms) in the cost of this category of services occurred at Surgutneftegaz — the per-job cost across this company grew by over 281 percent to around 4.2 million rubles between 2005 and 2011. The company has been targeting the most sophisticated and advanced applications and does not seem focused on saving.
From 2005 through 2011, Slavneft ranked second in workover costs. In 2011 the average cost of a workover in this company was 2.5 million rubles. Slavneft works mostly in ageing fields, which require increasingly sophisticated workovers.
In 2012 workover costs continued to rise across most of the sector. Surgutneftegaz and Slavneft remained clear leaders in this category (with 4.832 million rubles per job and 2.760 million rubles per job, respectively).
The only exception from this overall trend of rising workover costs in 2012 were the following companies:
» Gazprom Neft (which saw its workover costs decline by 28.8 percent over 2011)
» RussNeft (a decline of 25.8 percent)
» TNK-BP (a decline of 27.3 percent)
At Gazprom Neft and RussNeft, the cost decline resulted from the cumulative benefit of previous years’ operations, as the companies had already completed expensive workovers on many of their wells. At TNK-BP, the cost decline was due to the cost-cutting efforts during the pre-sale mobilization of the company.
If we combine the summaries of the financial and physical aspects of the current market described above, the result may at first glance seem quite satisfactory – as long as we do not delve into the details of the service demand and supply equilibrium, which is clearly skewed toward the latter.
Work Conditions to Get Even Tougher
When describing the above situation in the oilfield services market, most industry experts define it as quite worrisome, although not without hope for service providers.
More specifically, Bashneft – Service Assets General Director Kamil Zakirov says that “the oilfield services market has not yet fully become a customer’s market – in some segments demand outpaces supply. But in general the work and service price dynamics have stayed below the level of inflation”. And he does not think the situation will get any better going forward. For instance, Rosneft will have to give up TNK-BP’s practice of long-term contracts and will switch back to annual contracts. But the small-company sector will avoid multiple bankruptcies because the overall market is growing.
But other oilfield service companies have a more pessimistic outlook. For instance, Gazprom Burenie believes that the work conditions have become tougher and tougher each year. And 2012 was no exception and continued on the trend observed since around 2010. Last year, drilling service rates nationwide grew by a factor that is two to three times lower than annual inflation. In some regions, such as Novy Urengoi, they even declined. In contrast to foreign counterparts, Russian contractors have to shoulder certain risks, such as geological risks. This is a requirement typically put forward by customers even before bidding begins. Drillers, if they want to bid, have to accept it. If risks are materialized, contractors may incur significant losses, which is particularly detrimental to small companies. And given the shrinking customer base, the conditions will get even tougher over the next few years. In fact, this is already happening. According to Gazprom Burenie, small – and sometimes not very small – companies are leaving regional markets. This process is already observed today, in particular, in the Samara region.
Newsco, a company engaged in drilling engineering support, MWD and LWD services, notes that the cost of oilfield services during the past year remained nearly unchanged, putting companies within this oilfield service segment in a difficult economic situation.
Burintekh believes that Russian oilfield service companies are being rapidly driven from the market by more powerful international competitors. And the domestic providers do not receive any government support, something that feel entitled to. Subsoil users reap considerable profits, while many service providers, especially Russian ones, are pushed to the brink of survival. Moreover, the problem of delayed payments for services has recently deteriorated. It seems as though the more economically vulnerable oilfield service companies “credit” subsoil users, who are far better off financially. Burintekh predicts that if nothing changes in the next two or three years, Russia will be faced with a situation where a small number of subsoil users will be pitted against an equally limited number of big oilfield service provider holdings, including foreign ones. And it is impossible to predict which way the markets will go after that.
Thus, in three to five years, as oil companies increase pressure on their service partners, the Russian oilfield services market may well find itself in a peculiar clinch situation where a small number of subsoil-user customers will defend their turf against a limited pool of powerful oilfield service provider holdings. This may happen after a mass market exodus of small and medium-size companies, which are critical to maintaining a healthy competitive environment. Whether or not this situation will benefit the Russian petroleum industry is a subject of a different discussion.
