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Home / Issue Archive / 2006 / July #7 / Doing Business in the Russian Oil Patch: Now or Never

№ 7 (July 2006)

Doing Business in the Russian Oil Patch: Now or Never

The buzz word, partnership, seemed to be heard like a mantra through all five days of the 11th International Exhibition of Equipment and Technologies for Oil and Gas Industries (NEFTEGAZ 2006), held at the Moscow Expocenter on June 19-23. Some 900 firms from 35 countries filled the exhibition stands in search of business partners, with the most advantageous locations assigned to over 500 Russian companies.

By Anna Arutiunova

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In lieu of the G8 Summit, where Russia's role as a reliable energy supplier was to be a major agenda item, US-Russia and EU-Russia cooperation for the sake of global energy security was the cornerstone of the 4th Russian Petroleum Congress, held with the support of the Commission on Natural Monopolies of the Council of Russian Federation simultaneously with the exhibition.

The US ambassador to Russia, William J. Burns, set the theme of the congress with his opening remarks. "Never has there been a moment when Russia's role in the future of global energy security has mattered more, and never has there been a better moment to revitalize the US-Russia energy partnership. Energy security is not just another slogan, but a product of a responsible partnership."

Since Russia is the largest producer and exporter of hydrocarbons in the world (the US being the world's largest consumer), western corporate and government leadership clearly recognizes that Russia already is a world class energy player with serious potential and competitive advantages, such as a well-developed transportation infrastructure and extraordinary human talent. However, as many speakers implied, "cooperation" for Russia is synonymous with a metamorphosis of its investment climate.

According to the US ambassador, in order to take advantage of the opportunities before it and overcome the extraction and transportation challenges it faces, Russia will need billions of dollars in foreign currency. Thus, Russia should work on creating both downstream and upstream investment incentives and reworking its energy tax regime as well as the tariff system (giving tax breaks to western companies that crave to take part in complex offshore development, for example), while prioritizing transparency of both resource and revenue, price stability on the domestic market, and sound business practices.

Likewise Englishmen, Russia's most lavish foreign investors at present, want to see large scale changes implemented by the Russian government. Dr. Richard Marriott, the senior economist and head of International Energy Policy at the Department of Trade and Industry of the UK, urged Russians to ratify the Energy Charter Treaty. Doing so would not only boost international good will towards Russia, but lend countenance to its repute as a credible and reliable supplier as well. "A long term energy relationship is a fact of life and is desirable, we are partners and we share a continent," said Dr. Marriott, supporting his words with a description of potential long term UK-Russia energy contacts that would involve sharing of experience and technology exchange and shun a strict supply-demand model.

Investors are not philanthropists, however. As gas demand is driven up by the power sector and western dependence on imports from non-OECD countries grows, America too realizes a need to invest in Russia's LNG potential (given that Russians improve domestic gas use and decrease gas flare, of course).

According to Michael Robertson of Chevron Global Gas, most Russian gas is currently exported to Germany, Italy, Turkey, and France. However, as the North American market runs short of gas, the shortage is likely to be filled with LNG. Heavily endowed with natural gas resources, Russia could become a major supplier to the US market, as American LNG imports grow to 25 percent by the year 2025. Russian gas would certainly have to compete with existing and new players in the US, but Chevron offers to prop the market door open wide with a strategic partnership, as Russia makes legislative efforts to make its gas more competitive. Russians have already taken a few baby steps in the American direction - in September and December 2005, Gazprom delivered its first two tankers with LNG to the US.

Having spoken of all the things Russia needs to address on its end, some speakers pointed out that a partnership is not a one way street. "Russia always made a best effort to be a reliable supplier; European governments should feel lucky to be near such a willing partner," noted Daniel Simmons, the natural gas expert of the International Energy Agency.

Lev Feodosiyev, Ministry of Economic Development and Trade of the RF, embraced the possibility of using taxes and tariffs as means of improving the Russian investment climate. For example, Russia could lower tariffs on certain oil and gas equipment imports, which wouldn't hurt domestic companies who simply don't produce this particular kind of equipment. He did, however, seem averse to the idea of letting foreigners near the actual Russian oil and gas sources.

"Russia will never be against conscientious investors. But any country protects its interior," explained Feodosiyev, citing proposed legislature that would allow only Russian legal entities to participate in actual field development, and limit or shut off foreign access to strategic Russian oilfields entirely. Evgeny Danilov, attorney-in-chief of Pepeliav, Goltsblat and Partners, added that "The message of President Putin to Federal Assembly is sometimes considered abroad as the display of imperial ambitions in the oil and gas sector, but protection of natural interests exists worldwide."

In short, if a European partner wants to be invited into Russia (but not too deep into it), they must invite Russia to Europe too. Also, since the security of supply of any given source is only as good as its transport route, gas importers have to become active in securing reliable transport, and not just make it the problem of the producers. "The US and Russia have a great deal more to gain by working together than by working apart," said the American ambassador.

But enough theorizing. One of the best examples of actual current Russian cooperation with the west discussed at the congress, besides the North European Gas Pipeline that's part of the EU-Russia dialogue, is that of ConocoPhillips and LUKOIL. ConocoPhillips is the third largest US oil and gas company that invested more than $7 billion into Russia in the past year and a half through its partnerships with LUKOIL, Gazprom, and Rosneft, and hopes to own some 20 percent of LUKOIL by the end of 2006.

Kevin Meyers, president of ConocoPhillips' exploration and production segment and one of the board directors of LUKOIL, revealed to the congress the tricks to doing successful business in Russia by explaining his current business model. The basic model consists of partnering with strong Russian companies, structuring to align interests, and sharing knowledge and best practices. "We rely heavily on the three P's," noted Meyers. "Be patient, be polite, be persistent, and recognize that you're in Russia. I have special respect for Russia because it has a long history of successful development of its oil and gas fields, and because it's a highly developed country with a rich history and cultural traditions." Meyes, however, did not fail to mention that one of the tricks that lead ConocoPhillips to success is working closely with the Russian government.

Smaller companies, however, are reluctant to talk politics. They prefer not to venture into the Russian expanse alone, but either form partnerships with local Russian firms or with the larger companies already established in Russia, following them inland. "Big company investment brings medium companies with the wave, as there's increasing demand for our products," says Thomas Teichert, the sales manager at KКchele Vibrastop, a German company that has operated on the Russian market on its own for just two years, selling even WallR stators and rotors for progressive cavity pumps, downhole pumps, drilling motors and high pressure surface pumps.

Oil States Industries, Inc., a Texas based company, wants to produce some of its equipment in Russia that would require a solid status and clearance with the Russian government. Ricky Simic, the company vice president for sales and marketing, admitted, "The best way for us to expand here would probably be to buy a Russian company, because sometimes it can still be politically difficult for foreigners to do business in Russia, although the Russian political climate is changing and becoming more positive."

Teichert agrees, "Certainly the hardest thing about doing business in Russia is meeting all the formal bureaucratic requirements, where you have to know a thing or two about them before you can meet them. But there are also communication problems. We need bilingual personnel."

Language and geographic proximity issues resonated with other foreign companies entering the Russian market as well. "The biggest challenge is doing technical talk with people who don't speak the language," expounded Antony Armstrong of Anson Ltd., a leading manufacturer of exploration, drilling, stimulation and production equipment. "One way to overcome this challenge is to start offices in Russia with Russian staff, which can still be rather difficult," he added.

Yet other Europeans see competition from both within Russia and abroad as a major hurdle to their conquest of the Russian oil and gas market. Francesco Abba, the sales and marketing director of Cannon's Bono Energia, the main Italian producer of thermal fluid heaters and industrial boilers, says that his company has two reasons to be in Russia. "As the price of oil per barrel grows, companies have more money to spend, driving up demand for our products. Also, Russia is generally getting richer with time, and people are learning English."

But besides high demand, Bono Energia is also faced with a rather intimidating competitor who threatens to overtake their niche in the Russian market. "Germans are riding the BMW and Mercedes wave into Russia," lamented Abba. "German cars have a solid reputation in Russia, although their oil and gas equipment might be less developed," he warned.

Despite Abba's elucidation, German presence was the most conspicuous at the exhibition, after that of the locals. KКchele Vibrastop's stand bustled with prospective and existing partners, both Russian and foreign. "Russians and Germans have a profound cultural relationship shaped by centuries of interaction, besides geographical proximity," explains Teichert. "Russians are good at technology, but the Germans are more on the commerce side, so we combine the two successfully."

Despite the US-Russia cooperation buzz at the congress, few American companies actually participated in the exhibition. In Simic's opinion, the lack of American interest is due to the corporate giants being too involved domestically to venture abroad, which will result in a set back within a few years as markets grow overseas. Others, such as executives as Argus, Ltd., a US company that's been doing business in Russia for over 25 years, contemplate that "it's just too darn far for most."
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