IRJ Special Report: The Russian Connection

The Russian Association of Oil and Gas Equipment Producers is made up of all major Russian manufacturers of machinery and equipment for the oil and gas sectors. With the interests of its 145 members represented in the government of the Russian Federation, the organization has a tall order to meet.

The IRJ caught up with Alexander Romanichin, President of the RAOGEP to learn about the current state of play in Russia. From developing legislation to a blotted history of the oil and gas industries in the region, from the major players to the great lengths the Association goes to in pursuit of further statutory reform, Romanichin sets the record straight on one of the world’s most exciting resources hubs.

IRJ: Mr. Romanichin, is the Oil & Gas Equipment industry a new manufacturing sub-sector for Russia?  How did it emerge and develop?
Alexander Romanichin: Yes, this is a relatively new sub-sector of Russian machine-building – in the Soviet Union most of the oil and gas machine building was located in other areas during the time of the Soviet republics – Azerbaijan and Ukraine. Of the major producers of oil and gas equipment, perhaps only «Uralmashzavod», manufacturing drilling rigs was located in the territory of the Russian Federation.

After the collapse of the Soviet Union due to the lack of appropriate facilities in Russia, the importation of oil & gas equipment reached significant volumes. The country’s leaders, together with the «Gazprom» and oil companies prepared a program of conversion. Under this program, a significant portion of companies previously operated by Minoboronprom’ s (Ministry of Defence Product Manufacturing), Minsredmash (Ministry of medium-sized machinery Manufacturing), Minobschemasha (Ministry of General Machinery Manufacturing)  and other ministries from the famous «Nine», working for  the Military Industrial Complex, have been reoriented to  oil and gas equipment production. For examples of successful conversion, look at such companies as  Federal State Unitary Enterprises  «Uralvagonzavod» and «Votkinsk plant», JSC «Motovilihinskie plants» and some other enterprises of MIC.

The oil and gas equipment manufacturing sector was established in Russia virtually “from scratch”. This came with its own positive and negative implications.
On the one hand – technical and technological levels at the MIC were higher than on traditional oil and gas equipment manufacturing plants, which led to improved quality of manufactured equipment.

But on the other hand, the defence industry did not have a multi-year relationship with consumers and experience in the development of oil and gas equipment. In some cases, designed and manufactured in the military-industrial complex oil and gas equipment did not fully comply with the requirements of consumers, or was too expensive. But in general due to the conversion and reorientation to the companies from the defence sector, the level of quality in the oil and gas engineering (in contrast to the automotive, aerospace, machine tools, etc.) increased substantially.

It should be noted that Russian oil and gas engineering is different from the automotive industry, manufacturing of equipment for energy sectors and other sub-sectors of machine manufacturing because of a large number of separate plants. The meaning of our “oil & gas equipment production” sub-sector is blurred nowadays. Many of these companies are involved not only in the manufacturing of oil and gas equipment, but also produce defence products, road construction and other equipment. In Russia there are over 200 companies involved in oil and gas equipment engineering and production.

With the collapse of industrial control systems, oil and gas equipment manufacturers began to look for ways to consolidate which would lead to a more successful interaction with their customers. There was a need for a capable organization, which could enable the gathering of information and convey the position of most producers of oil and gas equipment to the public authorities.

IRJ:  Was this role was assumed by your union?
AR: Yes, we were established in 1998 and celebrated our 10th anniversary last year. The Union was organized on the initiative of the First Vice-Premier Y.D. Maslyukov, and was backboned by the defence complex enterprises.  Annual meetings of the heads of the defence industrial and oil & gas equipment production complexes organized by the Union have played a big role in bringing together the positions of two key sectors of our economy. Largely thanks to the Union, a shift from confrontation between the defence industry and oil and gas companies, which took place at the initial stage of this market, changed into a constructive dialogue and cooperation.

However, the recent years have necessitated the consolidation of the oil and gas machine building, not only within the framework of the association, but also in large holdings.

IRJ: Consolidation – it’s not an end in itself. What are the causes that forced the plants adjacent to the holdings?
AR: Some companies are not in a position today to compete in the market with foreign firms. There is a need to invest in the development and introduction of new technology, you need to create and fund a marketing service to promote the equipment on the market. You need to update machinery and factories to attract qualified personnel, to work with foreign partners and financial institutions. It is necessary to form a regional network of sales, services and repair equipment supplied. All these goals can be successfully reached only by larger structures.

I firmly believe that the producers of oil and gas equipment should be able to talk on equal terms with their customers. So far this has not happened – very different weight categories. At the oil tenders the oil prices offered to plants fell to lower plinth, the factories were forced to work with a minimum profit, and, of course, they did not leave funds to invest in their development. It is difficult for individual plants to attract “cheap” foreign loans in order to be competitive at tenders. In short – these companies did not evolve, but tried to survive.

What do we have today in the pipe market? Only three players – OMK (United Steel Companies), TMK (Pipe Steel Company) and ChTZ (Chelyabinsk Tractor Plant). In the market of the power engineering industry there is also one leader – Power Machines. They work with RAO UES (United Energy System of Russia) in railway engineering for the Russian Railways on co-operation with «Transmashholding». These are large market-based companies, successfully interacting with the natural monopolies and large customers. These holdings can compete with foreigners and promote industrial exports.

Globalization of the oil and gas engineering industry is a global trend. Abroad, active processes of merging and consolidation of companies are taking place. The processes of the enterprise merging have led to the emergence of major players in the market of oil and gas engineering. Thus, as a result of decades of acquisitions and mergers of ordinary American companies manufacturing and supplying contractors with drilling equipment, in 2004 National Oilwell consolidated nearly 50 per cent of the world market for drilling equipment. Since adding the company Varco in 2005, the market has been totally dominated by this drilling equipment giant, controlling up to 90 per cent of the world market at some segments. At the end of 2007, National Oilwell Varco first entered the top five most profitable U.S. companies.

IRJ: Are there already any examples of such holdings in your sub-sector? Is the market threatened by the oil and gas machine building monopolism?
AR: Holdings in oil and gas engineering began to emerge only recently. Groups like «HMS», «Integra», «Borec» and some others. It is these companies that now show the best results in the growth of production, introduction of new technology, exports and other indicators.

There is no threat to have a monopoly in this industry – there is so broad range of products in the oil and gas engineering. The challenge now is in the consolidation of disparate businesses.

IRJ: And as customers – oil and gas industry? What is their attitude towards the consolidation of suppliers?
AR: Today, Russian oil and gas companies are beginning to reduce the number of its counterparties, and move on to the long-term contracts. On average every year a Russian oil and gas company signs tens of thousands of contracts for the supply of services and equipment. For example, BP in all the North Sea projects signs around 60 integrated long-term contracts a year. In other words, there is a shift from annual tenders for long-term contracts. Such contracts are signed only with large holdings. For example, TNK-BP has signed a long-term contract for the supply of oil pipes to the holding company TMK. Gazprom has signed the largest in the history of Russian oil and gas machine building holding a contract with the «Uralmash-Drilling Equipment». This trend will grow – long-term contracts allow engineering firms to plan their activities and effective use of scientific, technical and productive capacity. But it must be large companies.

Only a large machine-building holding company can provide a decent service for delivered technologies. This is also a general trend – increasing the share of services in total turnover of engineering companies. Today, it is important not only to manufacture the equipment, but also to carry out installation, service, organizing the supply of spare parts and ensure the upgrading of technology.

IRJ: In this regard, one cannot help but mention the State Company «Rosoboronexport» (Russian Military Industry export company). Could it help producers of oil and gas equipment as well?
AR: Yes, it can. Especially in offshore oil and gas projects. These days Russia begins the implementation of major investment projects for the development of hydrocarbon deposits on the shelf of the Barents Sea. The development of Shtokman, Prirazlomnoye and other fields should not repeat the situation with the PSA projects in Sakhalin, which were realised practically without the participation of Russian machine-building enterprises.
One characteristic of the projects on the shelf is a need for an integrated supply of equipment to foreign investors. Suppliers are determined by the results of tenders, in which foreign companies participate as well. It is hard for Russian factories with no such previous experience and working capital, to work with foreigners without the help of a mediator company specializing in foreign trade. As a result, plants lose their orders or supply in their own country through a foreign company winning the tender. Experience in Sakhalin proves how useful it is for FSUE «Rosoboronexport» to participate in tenders for the supply of industrial products for the development of the shelf.

Federal State Unitary Enterprise «Rosoboronexport» has a successful history of collaboration with foreign firms, and (through the military-technical cooperation) with the enterprises – manufacturers of the equipment to work on the shelf. In particular, this State Enterprise has a long and successful co-operation history with shipbuilding enterprises, engaged in manufacturing of oil platforms. Federal State Unitary Enterprise «Rosoboronexport» has the ability to co-operate successfully with «Gazprom» – the owner of a controlling stake in the project to develop the Shtokman field.

Potential suppliers of products to work on the shelf are the enterprises of various sizes, forms of ownership and departmental affiliation. A possible form of consolidation is a consortium (according to the laws of the Russian Federation – a simple partnership) of Russian companies for performing works on the shelf. «Rosoboronexport» could lead such a structure.

IRJ: How about the export of Russian oil and gas equipment?
AR: Of course, «Rosoboronexport» has developed a network of offices in the Middle East, North Africa, India, Venezuela, Iran and other countries – the potential buyers of Russian equipment. «Rosoboronexport» is qualified to work on the international market. It is able to attract money to fulfil their contractual obligations, to organize a large group of cooperating enterprises. It’s important that the representatives of «Rosoboronexport» are based at many defence industry enterprises which produce or are capable of producing competitive oil and gas equipment. It’s also a question of reputation. «Rosoboronexport» is well-known abroad and foreigners are not afraid to deal with them.

Therefore, the potential of «Rosoboronexport» in the export development of civil products is very high. Same as in the supply of equipment for the development of the shelf. The only problem is that «Rosoboronexport» is not very willing to do that. Maybe they have enough work on the sale of military equipment. But I am confident that we’ll begin this important work through the new State corporation «Russian Technology» together with the Russian Machinery Manufacturer’s Union, which is headed by S.V. Chemezov.

Since the conversation has gone on exports, I cannot fail to note that the true reason for the sharp decline of exports of Russian oil and gas machine building is not in the low level of quality. Equipment, as I said, has become better. The problem is that our oil businesses have exited from many countries. In their place came the Americans. Naturally, the Americans will dig in his usual drilling rigs by National Oilwell Varco, and not on the rig from «Uralmash». Moreover, they are actively supported by State.

IRJ: How?
AR: Through the system of export-import banks. Why did U.S. imports of oil and gas equipment to Russia increase so dramatically in the mid 90’s?  It’s that simple. U.S. EXIM Bank started to give related loans to our oil companies. A condition for obtaining a loan was the purchase of American oil and gas equipment.
Today these methods are applied in China, actively crediting the buyers of drilling equipment in Turkmenistan and Kazakhstan, providing drilling machines without pre-payment. Naturally, this significantly increases the possibility of the Chinese machine builders.

IRJ: What about the support of State? How can the government support Russian producers of oil and gas equipment?
AR: It does not have to be State budget money as in China. Although I wonder why the system of state support of industrial exports, which is available in all countries around the world, has not been started in Russian for many years. In Russia Roseksimbank was established in 1994.
We are not on agriculture, not in medicine, but on the most profitable sector of our economy – oil and gas complex. Conditions must be created to encourage customers to purchase the equipment in their own country.

IRJ: How can this be done?
AR: The state has a strong arm – the license for subsoil use. Let’s tie issuing licenses with the obligation to subsoil using domestic drilling machines. This will bring many new jobs for people in this country, given that the drilling rig is very sophisticated equipment with a huge number of components.
Let us take the work on a shelf. In late 2007, many media outlets widely announced the signing of the contract between OJSC «Vyborg Shipyard» and OOO «Gazflot» (a subsidiary of «Gazprom») in the amount of 59 billion roubles, which exceeds a rate of $ 2 billion. According to the contract of JSC «Vyborg Shipyard » has to build two semi-submersible rigs (PPBU) to work on the Shtokman gas condensate field. The plant must pass the first PPBU in 2010, and the second – in 2011.

Experts note that from the significant amount LLC «Gazflot» received for this project more than a half went abroad. For example, topside for PPBU JSC «Vyborg Shipyard» buys from Samsung Heavy Industries (South Korea), and drilling equipment, which is about 40 per cent of the value of the upper structure PPBU will be purchased from National Oilwell Varco (United States).

In a crisis, when the Russian machine-building enterprises are forced to carry out the reduction, such a decision is puzzling. Naturally, the maximum utilization of the capacity of Russian industry for the project on the shelf – should be an important government issue.

Much is done at the regional level. I have good experience of Tyumen Region. Sergei Sobyanin, when he was the Governor of this area, introduced the practice of signing agreements with oil companies, providing development for scientific and technical capacity of the area. The Regional government partially reimbursed payments to the local budget of the tax on mineral extraction for purchasers of oil and gas field equipment, produced at the plants of Tyumen region.

IRJ: There is a lot of talk about high-level corruption in the procurement of oil and gas equipment. Is it a serious problem?
AR: In this respect I remember a statement made on TV once by the Chairman of the Council of Oil and Gas Equipment consumers Mr. Felix Lyubashevskiy, who was involved in forming a transparent system of logistics for a major oil company – TNK-BP. He was right in pointing out that it is necessary to break the stereotype when the job of suppler in Russia is associated with theft and corruption. Mr. Lyubashevskiy has worked with representatives of logistics for major foreign oil companies and has seen how proud they are of what they are doing.

Today, leaders of all major oil and gas logistics companies have joined the Council of Oil and Gas Equipment Consumers. One of the important tasks of this council is to create a transparent and open system of selection of suppliers. The Council is actively working on the introduction of common harmonized rules for logistics companies.

At the initiative of Mr. Lyubashevskiy, a register of suppliers of the oil and gas industries has been established, which provides the «credit history» of many companies. Companies like TNK-BP, Gazprom Neft, SIBUR, Slavneft and NOVATEK have joined the roster. This is an important tool in the fight against unscrupulous market participants. Until recently, every oil company has been keeping its own roster of suppliers, concealing information from their colleagues. This led to situations when a non-trustworthy supplier who had cheated on one of its partners, like Lukoil for instance, could still continue running its business and deceive TNK-BP, Rosneft, Surgutneftegaz and other companies. There is a need for exchange of information on suppliers of oil and gas companies. Both oil and gas producers as well as equipment suppliers are interested in such common Register.

It is difficult to overestimate the role of the Register if we want to work with foreign companies. Why do foreigners not acquire the Russian geophysical equipment, which is 5-10 times cheaper than the Western one, but not less effective? Nobody knows our suppliers. Many investors prefer to overpay and bring in imported equipment than to deal with an unfamiliar supplier. Therefore, the entry of Russian suppliers in the Register is an important task.

IRJ: How about corruption? Is it a problem for the current oil and gas equipment suppliers?
AR: Unfortunately, when selecting a supplier for our oil and gas companies, there are facts of corruption. Such managers will rob the company’s shareholders, therefore they should get strictly sued for commercial bribery in accordance with Russia’s Criminal law. The existing practice of tenders in Russia provides a good ground for corruption – there is no regulation and established practice standards for their conduct. The rules of civil law are general in nature. There is no formal procedure for challenging the results of a tender, and managers of oil companies sometimes decide on the best offers by their own subjective judgement.

For the sake of justice it should be noted that there is a positive trend in Russia. Thus, if we compare the current situation in the supply of Russian oil and gas companies with the mid 90-ies, when there were no rules at all, the difference is very significant. State oil and gas companies and shareholders are objectively interested in the development of uniform and clear rules for the operation of the oil and gas equipment market.

IRJ: Mr.Romanichin, why would a company choose a Russian-made product? What are the benefits of Russian suppliers to Western competitors as far as quality of products meets the requirements of consumers?
AR: Oil and gas equipment – it’s heavy metal-consuming products, which makes it very expensive to deliver them over the seas. Our equipment is easy to use and quite durable at a lower cost. We have all it takes – skilled staff to work on this equipment, a lot of experience of its use, established maintenance and repair base. The equipment corresponds to the Russian standards.

As I said before, the quality of equipment has increased significantly in the recent years. If we do not know how to make something well – an electronic control system or a comfortable cabin for the operator for instance, then we import those parts from foreign suppliers.

Service is a very important issue. Here we have traditionally been behind ever since Soviet times. Only large companies are capable of producing service equipment and this is also an important argument in favour of consolidation.

IRJ: How serious is the staffing problem in this sector?
AR: It is a common problem to all of our mechanical engineering. Our situation is not the best as well. We have several years of conducting roster of experts in the field of oil and gas equipment and observe a significant aging of skilled personnel. We need to raise the prestige of engineering education, revive the system of job training.

The situation is much better at large companies. Let us take the same «Uralmash». There was a certain period of time when all engineering personnel, all the skilled workers had fled away. Some started to work in trade, others joined small businesses. Now the situation has changed dramatically. The new owner – a group of «Integra» – has greatly increased salaries. The plant began to pay good money and people have come back. And what’s the most important – the skilled workers, engineers and technologists have returned.

We are in shortage of good qualified personnel – that’s why it is so offensive that many go to work in trade. They should be required to return to production, design offices and engineering. Machinery can be purchased in an instant but qualified workers and engineers can’t be quickly prepared. Therefore, it is necessary to value the existing staff. They must be well paid. A poor plant is often struggling to survive itself and not able to offer good money. A large company that value its brand, keep holding rate of return, develop co-operation with foreigner companies, attract investment, go to the IPO – they can pay. Such holdings are able to attract the best graduates from professional schools, they are running internship programmes. These companies do not talk about the need to protect domestic producers, they are able defend their own positions.

Once again I would like to draw attention to the unacceptable situation with imports in the major oil and gas projects being implemented in the Russian territory. Oil and gas reserves in any, even the largest field will inevitably run out one day. What’s going to be left of the country from exploiting its natural resources? Environmental problems? Unemployment? Problems of resettlement of large numbers of workers? Debts for equipment, pipes, work for foreign companies? Or a powerful industry, which will not only successfully modernize its own oil and gas complex with minimal participation of foreigners, but also develop access to foreign markets? Until quite recently, Norway and China did not have anything, while we had a great many industrial capabilities to modernize the oil and gas industry. Now they are shown as an example to be followed and to learn from – how to make equipment for oil & gas industry. Why? The reason is that oil and gas engineering «is not on the agenda for those who are the real decision makers and have influence over customers. So this should be dealt by the Government of the Russian Federation itself. That’s why we need to establish a ECPs working group together with the Government Commission which would lead the re-shaping of oil and gas equipment usage policy on the basis of the domestic industry. Time is running out. Every month the Russian machine-builders are losing their market positions and the negative consequences of this are largely irreversible.

IRJ: What are the Association’s proposals in regards of crisis management?

1. To link the state support to the oil and gas industry complex with requirements to comply with licensing agreements in geophysics, exploration and drilling. To fix the rules of participation of Russian contractors in the development of oil and gas fields.
2. To secure examination of major investment projects in the oil and gas sector (development of strategic fields, offshore exploration, construction of pipelines) to promote participation of Russian contractors in their implementation.
3. To raise import duties on oil and gas equipment, analogues of which are manufactured in the territory of Russia.
4. To conduct expert analysis of the procurement of imports during the harmonization process of the investment programs for monopolies and oil & gas companies if a controlling stake of a company belongs to the State.
5. To require information from companies to be submitted about the export and import of products with high added value, including for oil and gas industry complex, in the state statistical reporting for business entities to ensure more efficient use of home-made products which could successfully substitute imported equipment.
6. To request the public representatives on the boards of directors of OAO Gazprom, OJSC Transneft, JSC Rosneft to formulate and submit to the Association of Oil & Gas Equipment Producers requirements for equipment for joint consideration of the possibility of more effective use of domestic industry.
7. To limit the mode of linked crediting in Russian oil and gas industry, when a loan could not be granted without organizing a tender attracting suppliers of imported equipment.
8. To set up a working group on the fuel and energy complex and reproduction of mineral resources together with the Government Commission for technical re-shaping of EPS aimed at monitoring the situation on the Russian market of oil and gas services and equipment, providing expertise, coordination and  raising these issues on the Governmental level.

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