№ 2 (February 2007)
Russia's Drilling Rig Industry Struggles to Cope
Russia's domestic drilling rig market is consolidating as domestic manufacturers attempt to stay competitive in a world where the demand for drilling equipment, fueled by high oil prices, outstrips the supply.
What happened to the Russian drilling market in the 1990's wasn't much different from what happened globally during the 1980's. When world oil prices tanked in the 1980's, drilling contractors sold rigs for scraps rather than keeping them in inventory. Manufacturers scaled back production, and when the industry picked up again, the supply of rigs was deficient. Because of the age and condition of the stock, drillers in the United States today spend more to maintain the 1,800 rigs active in the U.S. market, than they did to maintain the 5,000 rigs active when the market peaked in 1979-1980, Charles Perry, president of Perry Gas Processors, Inc. told MarketWatch. He added, "If crude oil prices were still down at $20 per barrel or less, almost none of the wells being drilled today in the U.S. would be commercially feasible."
Similarly in Russia in the 1990's, oil producers relied on Soviet era rigs, and because most Russian oil was produced in mature fields in West Siberia, technology didn't matter. Now, the quality of rig stock does matter, as Russian producers adopt more Western business models and look to develop new fields, including difficult reservoirs that require exotic drilling techniques.
Dynamics of the Russian Drilling Market
Drilling activity in Russia has been growing at a faster pace than the world's average. Rig counts, kept by international service companies and shared with the industry in order to make business planning more efficient, are hard to conjure in Russia. Until recently, the producers themselves controlled rig stock and did not share information with the market. Today, even after many of these service units have been spun off into separate companies, information is sparce.
"The oil equipment factories have been working at full capacity over the past two years," Alexander Oganov, general вirector of the Russian Association of Drilling Contractors (ABP) told OGE. "Drilling contractors as a class have grown in importance in recent years as Russian producers have spun off their internal service units. This improves market efficiencies in that drilling contractors can lease each others' rig stock and subcontract with each other to service several production companies at a time. Producers save money by not having rig assets in inventory. The current boom, with the leading oil producers spending more and more on drilling operations, ensures that investing in rigs is one of the best ways to make a profit." Still, ABP and All-Russian Conference of Drilling and Service Contractors ASBUR analysts say that the expense of drilling has grown by 15-20 percent while the drilling companies have been spending 30-70 percent more on equipment.
Incentives to Replace Aging Rig Stocks
This market transition forces Russian manufacturers to produce higher quality equipment to stay competitive. Ivan Rozhnov, Technical Director of Uralmash Drilling Equipment, raised the issue at a recent equipment suppliers' conference, Neftegazsnab 2006. Over 40 percent of rigs operating in Russia are more than 15 years old, he said, adding that equipment breakdowns and worker safety are major issues. But because high oil prices deliver profits across the value chain, Russian manufacturers can now reinvest and make quality and advanced technology a priority. "If things stay as good as they are now, we'll be talking about sustainable development of the industry, which is more of a future goal right now," says Oganov of the Association of Drilling Contractors. "We see our future in growing our producing capacities. All the factories need to prioritize modernizing their manufacturing equipment."
Oil companies which give priority to Russian-made equipment are especially concerned about quality. Rosneft, for example, has been progressively reducing the amount of money spent on foreign-made equipment from 19.5 percent of total equipment costs in 2004 to 9.2 percent in 2006. Rosneft's press center says that the company imports only if it cannot source a Russian analog. Equipment for which no Russian analog exists, includes, according to Rosneft: top drive systems (for installation of drilling rigs), mud cleaning systems, mud tank system/module and electric submersible pumps for horizontal wells and anamalous (high) temperature conditions.
Drilling rig manufacturers could learn a lesson from Russia's drilling bit manufacturers, which have managed to cope with foreign competition. But unlike bit manufacturers, rig makers haven't moved as quickly to put new technologies into production. Sources at Rosneft say the problem is that domestic equipment prices have risen even as quality has declined - a situation that gives companies a strong incentive to boost orders of imports.
China's Unique Approach to Growing Market Share
Chinese manufacturers have been as opportunistic as any foreign producer in devising methods to establish solid positions in the market. As Oganov explained, "The Chinese often choose to act through Russian suppliers of drilling equipment; they don't even need to establish joint businesses."
"They've been especially active in the mobile oil rig segment," Oganov said, citing as an example the Russian companies Rinco Alliance and Technofor. The latter specializes in supplying Chinese-made oil equipment for Russian businesses, according to the official website. The items available for purchase, notably mobile drilling rigs and diamond drill bits, have been "certified in full accordance with international standards, tested in the United States, Western Europe and Japan", and are (as the company's website puts it,) "fit to fulfill the demands of the Russian market." Companies like Technofor aim to strike exclusive dealer contracts with Chinese manufacturers.
In another effort to make the Chinese equipment they supply even more appealing, Technofor packages the equipment with a range of services: delivery, processing of customs documentation, as well as approving documentation and engineering services. Company officials are confident that they do not harm Russian producers. "We supply the Chinese equipment that has no analogs in Russia," says Evgeni Gorshkov, oil equipment sales manager for Technofor. "The goods we offer such as engines, drives, and valves, suit the Russian market perfectly and cannot be substituted by Russian-produced equipment. We're only helping the Russian market."
Chinese manufacturers are now looking to take the next step: producing within Russia so as to stand on an equal footing with local producers and take over an even bigger share of the market.
Looked at from the perspective of the drilling contractors (the actual consumers of the rigs), Russian manufacturers already have the assets to sustain the competition they face. They might find it redundant to rely on government protection or rush to modernize their production facilities. The main advantage of local manufacturers is that they are Russian companies which operate in Russia. "Russian equipment remains cheaper and the quality is about as good as that of imports," comments Eduard Korolev, head of the Oil Equipment Department at the "Neftegazoborudovanije" factory. "If you buy an oil rig out of Italy, for example, and something goes wrong, you have to deal with Italy for repair and spare parts. If your supplier is Russian and is in Russia, you save a lot of trouble," Korolev says.
The Western Approach to Dealing with Russian Market
Uralmash Drilling Equipment, a Russian manufacturer well known for its utilization of modern technologies, has risen to the challenge by cooperating with the German drilling contractor KCA DEUTAG, now owned by the UK-based Abbot Group. KCA DEUTAG recently bought cluster sectional drilling rigs made by Uralmash. Uralmash' drilling equipment is respected by ASBUR experts as the bellwether of the industry in Russia. Among its recent products is a modular drilling rig with 160-200 tons hoisting capacity which is easy to dissemble and transport.
Anna Ammann, manager of business development in Russia for the Swiss oil equipment supplier, Drill Quest AG, says that for the Russian driller, "importing rigs means not only larger investments but also requires well-trained personnel that can operate these rigs and make sure they are used at the fullest capacity." But Drill Quest AG is addressing the personnel problem by opening a training center in Russia. "The Russian market offers cutting edge technologies and great patented inventions," she says. "You'll also detect a tendency to effectively combine domestic equipment with imports, which requires a good understanding of the technologies you're working with and knowledge of the production you get from your suppliers. That's the reason we provide our Russian clients with detailed technical information regarding our equipment."
"Business in Russia has to be done Russian-style," Ammann continued. "You have to honor the supply deadlines, be knowledgeable of the way paperwork is done in Russia and of course be sensitive to the customs rules." Russian clients, she added, prefer to have "a close trusting relationship with their supplier, which they would expect to know all of their company's needs and take note of the specification of their orders, such as the preferred material, timetable of supplies, the climate they work in, etc."
What's R&D Got to Do With It?
The Russian government is concerned today with putting innovative technologies to work so as to re-establish Russia as a leading scientific power, and not just Europe's energy supplier. "Innovative projects are very much needed for the oil rig producers," Oganov says. "R&D is the cornerstone of the future development of the industry if the current income flow remains consistent. Innovative projects already exist within some segments of the oil equipment industry. But you can never get enough money to invest in R&D."
Gubkin Oil&Gas University's pro-rector and head of R&D, Vladimir Vinokurov, says government budget allocations to the university doubled in 2006 to 55 mln rubles, compared to 27 mln in 2005. "I'm confident it'll be even more this year," Vinokurov said. "The State budget, the Moscow City budget and the Ministry of Industry, Science and Technologies have all been investing in us. The stipends for young scientists are growing. We're getting more funds. We expect it to peak in the next two or three years." He added that he thinks "there is a strong connection" between the increased government financing and high energy prices.
At the same time though, the companies themselves don't seem to be listening to the message of the Russian government or industry organizations like ASBUR. "Leading oil companies haven't approached us with any serious projects," acknowledged Vinokurov. ASBUR's research shows that Russian companies often ignore opportunities to develop R&D, preferring instead to just import the higher tech products. Korolev of "Neftegazoburodovanije" says, "The existing projects are more future-oriented. Whether it's satellites that control drilling activities or some other kind of gadget, the boost they can give to the high-tech industry can't be underestimated. Development of new solutions will give Russia a chance to make a fortune not only from the crude oil but from the equipment used to drill the oil wells."