An untapped potential

Russia is a world powerhouse when it comes to oil and gas – but it’s full potential is still not being realised nearly two decades after the break-up of the Soviet Union. In an O&G exclusive, Gennady Shmal, President of the Union of Oil and Gas Producers of Russia, pulls no punches in his candid assessment of where the industry needs to drastically improve in order to compete on the world energy stage.

Since the break up of the Soviet Union the oil and gas industry has changed very little. In the beginning it simply changed to the worst, when the production level dropped dramatically. For example, in the early nineties production dropped to less than 300 million tons, comparing with 570 million tons the Russian Federation was producing in Soviet times. But the recession was overcome and for sometime the production showed annual growth. Nevertheless, both oil and gas industries are successfully developing in Russia, making it the leading country in oil and gas production. We got ahead of Saudi Arabia in 2006, but since then we have gone level. In terms of production of hydrocarbons in general, Russia has a share of about 17.5-18% of the world production, which is of course quite a serious figure, and something to be proud of.

Unfortunately, there are some negative things to be mentioned. For instance, we’ve dramatically decreased the rate of exploration activity; therefore the increment of reserves is behind the production. This is an absolutely wrong approach. There was a common practice before – you produce a ton, and you must increment a ton and a half of reserves. That’s why when we were producing 600 million tons of oil in the Soviet Union, the increment of reserves was about one billion tons a year. During the last few years we produced 450-480 million tons, while increment of reserves was around 300-320 million tons. This is very bad indeed, because we need to think about the perspective. We’re not the last people on Earth, so we need to think of those who will live after us, and it means that we have to be more seriously involved in incrementing the reserves.

In terms of new methods, there is an ongoing introduction of new technologies and equipment, although maybe not in the scale we wanted. For instance, the US makes 20,000 hydraulic fracturing operations, widely used to improve the oil recovery. We make about 5000 – at just 25% of the US total, this is too little. However, our companies have learnt how to carry out hydraulic fracturing, drill horizontal wells, and do the off-shooting – things that were initially made in Russia by foreign companies, like Schlumberger, Halliburton and others. Therefore, many things that are used in the West are used here as well.

Furthermore, we have our own unique developments that are not existent in the West. For instance, I am in close contact with “RITEK” company. This is the only oil company in our country and in the world, which has the word “innovation” in its name – “Russian Innovation Fuel and Energy Company”. They use a lot of different innovations, in particular they have their own production of certain agents, which reduce the oil flooding, improve the well efficiency, and so on. They have intellectual capital of about US$200 million in various inventions and patents. This is just in one company, but there’s also LUKOIL, and Rosneft, and others.

On the another hand, there’s no some kind of targeted single directing hand, that’s why there are companies, that have professionals, who know what oil means, that do introduce innovative technologies, and there are other companies that don’t. Our oilmen from Tatarstan are working very actively. Sometime ago the production in Tatarstan was down, and during the last five years it’s going up. They produce over 30 million tons of oil every year. That’s why this is a very good and right approach indeed, and it’s not only there, of course.

As far as modernisation of existing infrastructure is concerned, this is a big problem. For example, we have lots of pipelines, operating not just 25 years, but over 30 years, although the standard life is 33 years, as in our norms. This requires in-line inspection, of course, which Transneft is actually doing a lot. It then quite quickly responds to the identified problems and fixes them, and for this reason the number of failures at our oil pipes has decreased 10 times in the past years. Our gas workers are also actively involved in in-line inspection, but not everywhere – at least covering about 70% of pipes per year. Overall, our pipelines are old so they need to be looked after and be reconstructed.

In addition, the efficiency of gas-compressor units is very low – about 22-23% today. That’s why a lot of gas is spent for own use, to pump this gas – about 55-60 billion cubic metres every year, and this is a lot. At the same time, there are gas-compressor units in the world, with the efficiency of over 40%, and if we talk about the steam-gas cycle, this can be even 70%. Therefore, if we could replace all the gas-compressor units with the new ones, we would immediately save at least 25-30 billion cubic metres of gas. This is a huge volume, which is consumed by a country such as France. However, assistance is definitely needed from western companies because our domestic engineering industry was not developing during the last years – it was the opposite – stagnating – and we can’t produce such gas-compressor units ourselves yet.

We need to rely on something that they have in England, for example. I remember around 10 years ago at a conference somebody showed me a Rolls-Royce turbine that back then had an efficiency of 45%. That’s why such things must be found and implemented. As experience shows, reconstruction of a compressor station, according to French experts, can be repaid in 18 months. But if we even take the adjustment ratio of two, it will take three years, and after that you will get a net profit. That’s why you have to work on that issue very seriously.

There are also many other problems. Despite the fact that the production is rather high, and there’s some growth, and that the oil and gas sector plays the leading role in the country’s economy (30% of GDP, 40% of industrial products, 70% of foreign exchange earnings), it all comes from the oil and gas sector. This is a lot and very nice indeed, but there are some absolutely absurd things going on because economic efficiency of the Russian oil sector is not high enough. For instance, in 2005 the net profit of all of the oil industry in Russia was US$25 billion. In the same year the net profit of ExxonMobil, which is just one company, was US$36.6 billion. ExxonMobil produces three times less than Russia. Shell had a profit over US$30 billion, and even BP, which is in the top seven world’s leading oil companies, had a profit around US$26 billion.

There are many issues here, but I believe the main one is that the structure of our oil and gas sector is irrational. We produce very much and refine very little. Of the 492 million tons that we produced last year, we refined about 215 million tons in Russia, and the rest was sold abroad as crude oil. Maybe there’s little difference in economics, but still there are outstanding issues with employment, improving quality, and so on. That’s why we think that we need to change the structure dramatically and significantly increase the share of refining either in percentage or in quantity. In the US they haven’t built a single oil refinery in the past 40 years. Unfortunately, we haven’t either but the Americans have the refining depth of 95-98%, and ours is just 70. Therefore, we are very concerned with this issue.

In addition to this, there are issues, related to development of new regions – Eastern Siberia, Arctic shelf, Caspian Region, which has a very strong potential, but which needs to be worked with. I also believe that our Russian legislation does not stimulate development of oil and gas industry at all. On the contrary, it strangles it: today’s customs duty is US$333 per ton of oil, and then you add the Extraction tax, which is directly related to international oil prices. This is an absolute nonsense, which we can’t prove to our senior economists. You have to ask what the production tax should be dependent on? First of all it should depend on the formation condition, its porosity, and permeability, such as on mining and geological conditions. Secondly, it should depend on geographic conditions: it’s one thing, when you produce oil somewhere in Kuban or Tuapse, but it’s a very different thing if it’s in Vankor or Talakan.

The next reason is availability of infrastructure. There’s no problem, if you already have all the oil pipelines, but if you have to build one from Vankor – this is extremely expensive. Therefore we believed, we do believe now and we argue that there must be a differentiated tax on production operations, even if not for every field, but for different groups or regions for sure. Today’s tax is about US$120 per ton. So you can do the calculation: US$333 and US$120 – this is US$453 per ton that the government is taking away immediately. Of course, our oilmen are not poor: they have good wages, and they have profit, although not as high as Western companies have. But this restrains further development.

Today, oil companies can finance the exploration works only from their profit. And where can they get the money for new research and development activities? It’s the same answer – only from their profit. Even if we talk about the utilisation of associated gas, there are new technologies, and they must be introduced. Therefore, today there are many things that require serious money, but you can’t get them, because there’s no profit, and not every company can afford to spend money on such things.

In addition, our people are working in very difficult conditions. Indeed, 70% of oil is produced in Western Siberia – Khanty-Mansiysky Autonomous District, Yamalo-Nenetsky Autonomous District, Tomsk Region, which produces about 10-12 million tons, but you can’t compare conditions there with London or Paris. These are the places in Russia where we have to create conditions for people to live a normal life. But what is the normal life? For the past years the prestige of such professions, like oil worker, geologist, and construction engineer went down. Today’s young people choose to become a guard, a lawyer, or a banker. That’s why, there’s a big problem as soon as it comes to specialists with high qualifications. In addition, we used to have accurate and harmonious system of personnel training – a system of professional technical education that was envied by all foreign countries. We had it and we destroyed it, but we have to think how to revive it again.

That’s why the issue of professional training, especially training of highly qualified professionals, is the priority among other issues. Because you can somehow solve other problems, some earlier, others later, but you must spend five to six years training a good welder of class six, and even longer time is needed to train a good logger. This issue must not be lost or neglected, and the earlier we take a hold of it, the faster we’d be able to solve the problems we have.

Gennady Shmal on extracting hydrocarbons in hostile regions with harsh climatic conditions

Firstly, in general the volume of exploration in these regions is clearly insufficient. Only nine to 12 percent of our shelf, which has a good potential, is explored. That’s why this is, as we say in Russian, “it’s on the back burner”, nobody hasn’t even thought about doing it. Of course, at the moment present we’re using advanced technologies – satellite for instance.

We are mainly using shots from French and American satellites in order to increase probability. The geologists have a specific term “luck rate”, meaning that if you drill 10 wells then you watch how many produced oil. If five, then your luck rate is 0.5, if seven, then it’s 0.7. When we worked in Western Siberia, our luck rate was normally one – every drilled well revealed some deposits, some reserves. This is not the case now, of course, but the new technologies, which are appearing now or have already appeared, in geophysics and seismic surveying in particular, help us to assess things.

But as my teacher Viktor Muravlenko, very well known oilman, used to say: “Oil is on the edge of drill bit”. If we won’t drill a well, we’ll never know. Yes, maybe there’s oil there, but what kind of oil, what are the formation properties, what are the production parameters – only the well can give us the answers to these and other questions. That’s why you should drill. And what does drilling mean? An offshore exploration well costs on average US$40-50 million. That’s why when they say that Shtokman or Prirazlomnoe was discovered, you need to use all these advanced technologies.

In addition, we are keeping an eye on what’s going on abroad. In January in Kaliningrad we had the sixth traditional meeting of Russian and Norwegian oilmen. The Norwegians did a lot and worked out many technologies to be operated in Arctic offshore. Although Americans have been working offshore for a long time, they work in conditions of the Mexican Gulf. The Norwegians also have easier conditions, than ours – they have Gulfstream, therefore they don’t have big icebergs. In any case, you can take off your hat to them, because they have developed very many interesting technologies. For example, they are currently working on making a fully submergible operation, without the platform. This is their Snohvit field. There are some problems related purely to hydraulics, but nevertheless, people are working there. That’s why we need to adopt such an experience. It’s good that they were asked to take part in the development of Shtokman together with Total. In addition, we have to adopt everything new that’s already available and not waste time reinventing the wheel.

What does the Union do for the industry? Gennady Shmal explains.

The Union is a public organization, created 16 years ago to assert and protect the rights of oil and gas companies. We take part in all parliamentary hearings on issues related to oil and gas, expressing our point of view and asserting our interests. Among other activities is lobbying our interests in the Government and other organizations. For example, in the Chamber of Commerce and Industry of Russian Federation there’s a Committee for Energy Strategy and Development of Fuel and Energy Sector, where I’m a Deputy Chairman, and Yuri Shafranik, who is the Chairman of the Union, is the Chairman of the Committee. That’ s why we have many crossing issues, one of the recent – issues related to the shelf development, exploration of Eastern Siberia, and so on.

We express our point of view, prepare documents, and on behalf of the Union send them to the Government, to the President, and if they go through the Chamber of Commerce and Industry, then they’re channeled through the Chamber’s senior officials. There are and always will be some issues with a perspective, which need constant pushing, and this is where the Union has an opportunity to express its point of view, not necessarily coinciding with the Government’s point of view, because we’re not dependant on anybody, and we don’t have any superior authority – just our members and founders. In this respect we have untied hands, and we have some influence.

Gennady Shmal is the President of the Union of Oil and Gas Producers of Russia, Chairman of the Board of Russian Joint-Stock Company “Rosneftegazstroy”, and VP of Russian Oil and Gas Contractors Union. He is the author of more than 100 scientific works, devoted to problems of increase in oil and gas construction efficiency.