Development of the Oilfield Development of the Oilfield Services Market in RussiaServices Market in Russia

Moscow

2-3 December 2003

Yevgeny Bulgakov

22

AgendaAgenda

1. The Development of the Oil Field Services Market

2. Competitiveness of integrated and independent Service Companies

3. The Development of a «Russia-wide» oilfield service market in the context of the consolidation taking place in the Russian E&P industry

4. The Place of International Service Companies in the Russian Market

5. Conclusions

33

Structure of the Upstream Oilfield Services MarketStructure of the Upstream Oilfield Services Market

Upstream Service Activity

Service Source: (Internal/External) Market Participants

Exploration Related Services Seismic Acquisition External Russian Data Processing Internal and External Russian and Western Exploration Drilling Internal and External RussianField Development Field Planning and Modelling Internal and External Primarily Russian Engineering Internal and External Primarily Russian Construction External Primarily Russian Contract Drilling Internal and External Primarily Russian Drilling Services Internal and External Primarily Western Transportion Internal RussianProduction Operations Well Repair Services Internal and External Russian and Western Facilities Maintenance Internal and External Russian Equipment R&M Internal Russian Field Transportation Primarily Internal RussianOil and Gas Transportation Pipeline Maintenance and Repair Internal Russian

Primarily InternalInternal and ExternalPrimarily External

44

The Evolution of the Oilfield Services Market: TNK-BPThe Evolution of the Oilfield Services Market: TNK-BP

Phase 1Services Internally Owned, Integrated into Upstream

Operations

Phase IIServices Segragated

into cost centers

within Production Operations

Phase IIIServices segreated

into separate business units

operated at arm's length

from Production Operations

Phase IVService Businesses

and Assets Being Divested to Specialized

Service Companies

Costs establishedarbitrarily

Transfer PricingCost plus profit

(Benchmarked to external market where possible)

Costs set by cost centers Market Pricing

All Service Supplied Internally

Most Services SuppliedInternally

Some competition between internal and

external service companies

Most services sourced Externally

1995-2000 2000-2002 2002-2003 2004 onward

55

Price vs. Quality Price vs. Quality When are Services Competitive?When are Services Competitive?

Ser

vice

Qu

alit

y an

d

Tec

hn

olo

gy

Service Unit Price

Internal Services

External Russian Suppliers

Multinational Service Companies

66

«Added Value» - A Method of Determing Competitiveness«Added Value» - A Method of Determing Competitiveness

• Service Quality• Time required to perform service• Cost of Service

Service Market

Dives

t

Hol

dHol

d an

d Dev

elop

Potential Value Added to TNK-BP from utilization of oilfield services

• Service Quality• Time required to perform service• Cost of Service

77

General Model of Value CreationGeneral Model of Value Creation for Upstream Operations for Upstream Operations

n

iWACC

i

r

C

i

i

1

SV

WACCr

CSV

nUpstream Production-

related expenditures per year by TNK-BP

TNK-BP revenues from oil sales

Value Created for ТNК-ВР

Average weighted cost of capital for TNK-BP

Service Companies create additional value for the Oil Producing companies Service Companies create additional value for the Oil Producing companies through:through:1. increase/acceleration of ТNК-ВР Revenues (Production) - «S»;2. overall reduction in ТNК-ВР Expenses (Capex and Opex)– «С»;

99

Russia’s oilfield services market: As is.Russia’s oilfield services market: As is.

Markets for oilfield services are not transparent.

Oil companies’ selection processes are biased in favor of in-house service units.

Work volumes for competitive tendering are limited.

Because external companies have to compete against oil-companies’ units operating as cost-centers, margins are too low to attract new players.

Infrastructure and access to auxiliary services are in the hands of incumbents.

Bidding and contracting horizon is explicitly short-term, disallowing any sensible equipment upgrades and limiting investment only to quick pay-back projects.

Safety factor is undervalued in comparing competing contractors, thus impeding the entry into the market for operationally advanced contractors.

1010

Russia’s oilfield services market: As it should be.Russia’s oilfield services market: As it should be.

Oil companies expected demand and expenditure information is shared with suppliers to enhance their investment and planning decisions.

Adequate work volumes are available to sustain business for external contractors.

Tendering procedures are transparent and consistent with the market policy.

Capital-intensive and infrastructure-dependent service markets enjoy long-term contracts.

Non-monetary criteria such as safety and environmental awareness become high-priority assessment factors.

Truly nation-wide service suppliers exist and operate across the country and across corporate boundaries.

1111

«Udmurtneft-bureni«Udmurtneft-bureniyeye»»

Established in 1969, Established in 1969, incorporated as an independent business unit in 1998.

Revenue Revenue – over $ 50 million per year

Geographical Spread of Operations Geographical Spread of Operations – Since 1997 they have operated outside Udmurtia, providing services around Russian and the FSU. They have been offered contracts in countries outside

the FSU.

Contract Porfolio includes a large number of Contract Porfolio includes a large number of customers including: customers including: Sibneftegas, Pertex, Tatneft, Ritek, Sibneftegas, Pertex, Tatneft, Ritek, Uralsk-neft, Belkamneft, Stimul, Alrosa (diamond mining), etc.Uralsk-neft, Belkamneft, Stimul, Alrosa (diamond mining), etc.

Management – Management – operate independently to develop and manage the business.

Workforce: over 2000Workforce: over 2000

Capacity and CapabilitiesCapacity and Capabilities: 30 drilling crews, 23 workover crews, engineering support center, horizontal drilling, cementing, transportation and rig moving, equipment repair, mining related services.

Udmurtneft-bureniUdmurtneft-bureniyeye: an example of a Russian : an example of a Russian Service company operating nation-wide.Service company operating nation-wide.

1212

Opening Internal Markets by VICsOpening Internal Markets by VICs

The Key to the Development of a Market for Oilfield Services in Russia is the willingness of most E&P operators to contract third party services

A market with multiple buyers and multiple suppliers reduces risks and costs for all parties– Service Companies can invest in establishment of servcie bases, service capacity and

introduction of new technologies to serve multiple clients - reducing costs for all– Mobilization costs are born by multiple clients– Utilization levels for service assets are increased, reducing unit cost of services– Internal Service companies do not need to invest to meet «peak loads»

E&P companies can offer some fraction of their service requirements to third party while retaining some internal capability

– As third party service companies are able to supply services at a cost and level of quality that meets pre-defined objectives, greater service volumes can be contracted with third parties

– Internal Service companies of one E&P operator can provide services to other E&P companies

• Allows benchmarking • Allows evolution of market relationships and skills which can lead to the spin off or

sale of the internal service companies at a later date.

1313

Federal Oil Field Services Data BaseFederal Oil Field Services Data Base

Development of an Objective, Neutral and Reliable source of information regarding Service Suppliers:

– Domestic Service Companies– Multinational Service companies operating in Russia

Information could include:– Actual Capabilities on the ground for each Service Company in various Regions of

Russia– Information on Service volumes performed in each region updated periodically– Some information on performance and service quality

Potential Value of the Data Base:– Benchmarking of service performance– Pre-qualification of contractors for participation in tenders– Input to contractor performance management systems– Expedite searches for specific technologies or know-how

1414

Multinational vs National Service CompaniesMultinational vs National Service Companies

Generally, internal service companies are benchmarked against and compete with other Russian companies.

Some clients even divide the tendered scopes into lots designed for national suppliers and those where global players are expected to win.

Even in markets where both Russian and Western contractors are active (e.g. fracturing services) there is a fair degree of job specialisation usually based on the size and complexity of the operation.

Therefore, there are clearly two distinct oilfield service market segments with a negligible overlap.

1515

Value Generation - Current SituationValue Generation - Current SituationS

ervi

ce Q

ual

ity

and

T

ech

no

log

y

Value Generation

Higher Quality does not necessarily generate more Value

Internal Services

External Russian Suppliers

Multinational Service Companies

1616

Why Higher Quality Does Not Necessarily Create Greater ValueWhy Higher Quality Does Not Necessarily Create Greater Value

Usually Imported Services provide the best technical solution and best quality but:

– costs of such services are high– mobilisation is costly and difficult– learning curve is costly to all parties– cost to the client of developing (or switching to) a different contractor

performance management system is high.

A “pure” imported solution may destroy Value rather than add Value!

1717

Value Generation - A Possible OutcomeValue Generation - A Possible OutcomeS

ervi

ce Q

ual

ity

and

T

ech

no

log

y

Value Generation

Internal Services

External Russian Suppliers

Multinational Service Companies

Market solution with Hybrid participants

1818

ConclusionsConclusions

Divestiture of internal service companies ensures continued market development

The development of the services market will enhance competition and enable the creation of more value for the oil and gas producers

The consolidation now taking place among Russian oil companies should be followed by the birth and development of nation-wide oilfield service players

The oil producers will be looking for hybrid Western/Russian solutions in pursuit of the right balance of price and quality to maximise added value

TNK-BP Approach:– Encourage the evolution of the upstream oilfield services market – Encourage other Vertically Integrated Oil Companies to open up their markets

to third party service companies– Encourage regional service companies to expand their operational geography– Encourage western service providers to acquire local assets and know-how