17-10-02 The owners of several major Russian oil companies are preparing their assets for sale for foreign investors. However, willing buyers would do wise to learn the methods the Russians have been using to achieve spectacular growth of production volumes and market capitalization. These methods are attracting open criticism of Russian government officials, including President Vladimir Putin.
Speaking in London in late September, president of Tyumen Oil (TNK) Simon Kukes said that the majority holders, Alfa Group and Renova Industries, had hired Goldman Sachs to consult them on increasing TNK stock value before sale of a large equity interest.

TNK officials do not hide that one of the possible buyers they are courting is BP. Yukos boss Mikhail Khodorkovsky also said recently that his company was prepared to sell substantial pieces of its equity to a foreign strategic investor. Rumours on future sale of Sibneft stock appear occasionally in the news as well.
These companies are obviously in the midst of a pre-sale bustle. Market capitalization of Yukos and Sibneft is soaring. Industry watchers pay particular attention to these companies’ dazzling growth of production (20 % at Sibneft and 17 % at Yukos in 2001), and also to their efforts aimed at enhancing corporate management quality and transparency.
However, as chief expert of the Moscow-based Institute of Financial Studies Grigory Vygon puts it, “it is impossible to get an answer from Yukos when analysts ask them about the methods used to boost production.”

During the last few years, Yukos, Sibneft and some other Russian producers showed a huge increase of enhanced-recovery operations. Industry experts differ in their opinions of this tactic.
“Some methods ensure a sharp growth of output initially, but in the final run they lead to a quick death of the field. You may squeeze everything you can from the field at the initial stage of development, and they get another Samotlor,” first deputy CEO of Surgutneftegaz Anatoly Nuryayev told.

In the Soviet Era, production volume was considered the all-important factor for the oil industry, and the giant Samotlor field in Western Siberia was mercilessly exploited without long-term plans to optimise output. As a result, most of the devastated Samotlor reserves became impossible-to-extract.
The fate of this field provoked President Vladimir Putin to say, during a meeting with oil companies’ top managers: “We skim the milk, and wells get spoiled.” It seems now that foreign investors, who might acquire interests in Russian oil companies, will have to share the concern of the Russian leader.

All Russian producers are increasingly applying enhanced recovery methods. In 2001 Surgutneftegaz, for instance, preformed 131 sidetracking operations, 140 % more than a year before (55 operations.) Incremental oil production amounted to 1.1 mm tons, 260 % over the 2000 level (303,700 tons.) The company is also increasing the number of hydraulic fracturing operations and coiled tubing drilling.
LUKoil produced incrementally 14.8 mm tons of oil through enhanced recovery in 2001, 10.7 % over the previous year level. A senior official of Sibneft told that such technologies enabled the company to almost double output at several Siberian oilfields.

The approach of the Russians to enhanced recovery differs from company to company. Surgutneftegaz makes it a principle to avoid western contractors. The company’s managers say that any technology and equipment can be bought on open markets, and their use comes out cheaper if Russian labour is used. According to Surgutneftegaz, well bore sidetracking operations by Russian teams cost 30 % to 50 % of the price charged by foreigners. Domestic hydrofracturing costs 20 % to 25 % of the average foreign price.
Sibneft managers disagree. They point out that Russian service companies lack some of the technologies applied by Schlumberger or Halliburton. “Even if the name sounds the same, the Russian quality is frequently below norm,” they say. LUKoil, which until recently used almost exclusively Russian-made technologies to enhance oil output, is beginning to contract foreigners for such jobs. LUKoil’s joint project with Schlumberger is expected to raise production at the Upper Vozei field in Komi through state-of-art chemical and physical methods.

In many cases, enhanced recovery methods are the right way to treat resisting reservoirs. For example, the original development plan of Sibneft-owned Sugmut field in Western Siberia made it non-promising, if traditional Russian technologies were to be used. Sibneft officials claim that new technologies make the project highly attractive. This year, Sugmut is expected to produce 8 mm tons of oil.
However, there are reasons to believe that the growing use of such technologies could be caused by the Russian companies’ wish to artificially achieve a short-lived production growth and raise their market capitalization before selling large portions of corporate stock.

These misgivings become more pronounced because Russian oil managers still feel reluctant to disclose information on the enhanced recovery technologies they use. Yukos, for example, which is striving to be regarded as Russia’s most transparent oil company, refuses to comment on its corporate policy in the methods of yield stimulation.
Sibneft is a little more transparent in this respect. One of its officials informed that the current production plan is based on expecting the oil extraction ratio to average 30 % this year. “We are planning to increase this ratio by 0.5 % a year, and it is a very impressive growth for a Russian producer. By 2020 Sibneft will recover up to 40 % of in-place oil,” he said.

Different approaches to enhanced recovery methods reflect a more fundamental gap between conflicting views on the destiny of Russia’s oil industry. Surgutneftegaz managers believe that it is not difficult to quickly increase output, as Yukos and Sibneft are doing, but at a later stage their production would plummet as soon as easy-to-tap reserves are depleted. Speedy oil recovery, they claim, may affect oil production in Russia: after a short period of extravagant growth, it will slide down again.
The views of Yukos officials are absolutely opposite. They insist that Russia possesses oil reserves sufficient to ensure annual production volumes of 420 mm to 450 mm tons.

According to Yukos, future technologies will help hard-to-extract deposits gradually become commercially recoverable. Today, they say, the industry must “skim the milk” and leave costly extraction of remaining reserves to descendants, who will be able to use unheard-of technologies to extract oil.
Driven maybe by conflicting stimuli, Russian oil companies are expected to go on increasing the use of enhanced recovery methods. It is unknown whether such methods are applied to actually optimise the reservoir performance or as a make-up before selling assets, because transparency is still a thing of the future in Russian business. This uncertainty increases the risks involved in acquisition of Russian oil assets. The buyer may end up with oilfields devastated to demonstrate “miracles” of growth.

Apart from production growth, there are other indicators to judge the Russian companies’ actual intentions and see, which ones are serious about long-term performance and which are relying on immediate results and disregard strategic prospects. The ratio of funds invested in drilling to one ton of oil production is one of such indicators. For Surgutneftegaz, it amounted to $ 22.50 in January-June 2002. It was $ 11 for Yukos, $ 9 for LUKoil and a meagre $ 6 for TNK.
Former deputy minister of energy Alexander Samusev, who is now CEO of Severnaya Neft company, said: “TNK is not doing anything at all, production-wise. They have other priorities in mind.” The priorities seem to be beautifying assets before their sale.