During Soviet times, oilfield services-from drilling to hydro-fracturing, downhole services, engineering and construction services-were geographically organized and attached to specific production organizations. There were drilling teams and oilfield-service brigades working exclusively in Tyumen, in the Ural region or in Tatarstan, and attached to their regional upstream state "companies." These teams were a depositary of technical excellence and operational capabilities corresponding to the operating environment where they worked, and the oil and gas fields' structures and reservoir conditions specific to their regions. With the break-up of the Soviet Union, these teams found themselves attached to the newly created Russian oil majors and operating under more commercially sound strategies. When the majors expanded their operations beyond original centers, and sometimes abroad, the service teams' lack of exposure to different environments and their unfamiliarity with the associated technical challenges became apparent. Meanwhile, foreign service companies that had arrived during the last years of the Soviet Union or at the very dawn of the New Era were in turn displaying a great deal of flexibility, cutting-edge techniques, and business savviness that was badly lacking to the home-grown players. Schlumberger, one of the earliest movers, started building a strong local base, cooperating closely with the local majors. The metamorphosis of the service sector is taking longer than the upstream reshuffling. While the latter first engaged in a rush for assets, followed by a streamlining of operations and a certain attempt to concentrate (notably under state implosion), the service sector has been rather slow to evolve. The main reason is, of course, its integration in the corporate structures of the Russian oil and gas majors, which are busy sorting out their upstream concerns before considering reorganizing and spinning off service divisions and other noncore upstream activities. Today, oil and gas majors still handle around 70% of their services internally, leaving only 30% to local and foreign companies. The time for more radical change has come, and the service industry has already shown some progress. Modernization First and foremost, the needs of the Russian industry have evolved fast, and the industry has learned to become extremely demanding on the services and technologies deployed upstream, midstream and downstream. This is partially due to the influence of foreign service players, who compete through sheer quality of service, and to radical changes in mentalities in the industry since the early 1990s. From a purely quantitative approach, the Russian industry has moved into a more quality-oriented approach, with renewed consideration ranging from more proper and careful asset management to a need for better reservoir understanding and care backed by the appropriate use of the latest technologies available, from state-of the art reservoir modeling and directional drilling to well stimulation. The use of these techniques also allowed foreign service companies to charge premiums ranging from 10% to 80% over Russian service companies' prices. With oil prices skyrocketing and easy oil getting thinner, the Russian upstream has been happy to spend the extra buck, and learn quickly how to unlock maximum value from its assets. The Russian industry has now looking at spinning off the last remnants of its formerly vertically integrated structure. Drilling teams have been spun off into subsidiaries, a prelude to their complete sell-offs and independence. Specialized operations have already been turned into independent companies and a few major service operators have been created. Midway between the oil and gas producer and the service player is Ritek, which is expected to produce 2.6 million tons of oil (19.4 million barrels) this year. Created in 1992 by the will of the giant Lukoil, the company was put in charge of developing difficult oil fields, depleted reservoirs and declining wells that the major was reluctant to exploit itself. The company has developed know-how and become a specialist in dealing with challenging production conditions, exporting its equipment and its technology to Oman, China and in the near future to India. From a major's divestment (although Lukoil is still the majority owner of the company with 59.1%), a strong hybrid niche player, both service provider and oil company was established. Valery Graifer, Ritek president and Lukoil chairman, says, "In the years to come, we'll continue producing innovations and extracting oil. For us, the innovative approach is a priority. Today, the standard oil recovery factor in Russia does not exceed 35%." Ritek works at engineering solutions that allow extracting 60% to 70% of oil from a well. "Thanks to fiber-optic systems, for example, we can significantly increase the oil-recovery factor and tap resources more carefully," he says. "I expect that all the efforts put into our research activities will bear fruit within two years." Another precursor in the service industry, this time a pure service operator, is Petroalliance, a company created in 1989 as a U.S.-Soviet venture. Based on cooperation with U.S.-based Western Atlas (now part of Baker Hughes), for years, the company has been the uncontested leader among Russian service companies, expanding its range of activities from seismic acquisition and modeling to onshore and offshore seismic surveying, well workovers, field modeling, logging, drilling support and other services. It has also been the only company able to compete head-to-head with foreign players like Schlumberger, Halliburton and Baker Hughes, betting on its perfect understanding of local operating conditions, the Russian oil and gas industry and associated political connections to ensure a strong presence in Russia, as well as in the Caspian region, notably Azerbaijan. In Russia, Petroalliance is estimated to control 4% to 5% of the oil-service market. The company has always been deemed very close to Russian giant Lukoil, which ensured it with a sizeable amount of work throughout its 16 years of existence. But lately its largest destiny shift came with the entry of Schlumberger as an investor in 2004 with an initial acquisition of 26%, confirmed earlier this year when Schlumberger purchased another 25%, bringing its total stake to 51%. The purchase of the rest of Petroalliance is in 2006. Today, with offices in Houston and Moscow, Petroalliance is a player to be reckoned with on the global stage, and Schlumberger's majority stake is a clear testimony of how the Russian service industry can also be an attractive playing field for the global industry. A new breed The game is certainly worth the effort, as most of the industry reckons that the overall value of the service market approaches $10 billion per year, with a level of maturity that has yet to match that of its Western counterparts. Despite the presence of most of the large international players and the rise of strong local contenders, the midsize market is relatively limited, and structured much in the way the top segments used to organize their services. The small and medium-size E&P companies still rely, in part, on their in-house capabilities to service their fields. In Tatarstan, for instance, most of the independents have enhanced-oil-recovery capabilities, cementing and casing, logging and usually a set of other capabilities. This, in turn, limits the potential size of the market highlighted by sharp increases in drilling costs, from $110 000 to $300 000 on average in only four years, (yet still well below Western averages). Higher costs have signaled that companies will have to look for more efficient ways to drill, and increasingly subcontract field operations, maximizing yields and asset life. This change in the operating conditions has encouraged the development of strong local contenders, with or without foreign backing. One such upcoming local player is Moscow and Samara-based Eurasian Drilling Co. (EDC). Today the largest private drilling contractor of the Russian Federation, the company is a spin-off from Lukoil Bureniye (Drilling), a subsidiary of Russia's largest upstream company. Following the acquisition of 11% of Lukoil by ConocoPhilips in 2004, EDC purchased the assets of Lukoil Drilling for $130 million, including $60 million in debt, and committed $75 million for equipment upgrades and renewals. Today, the company is Russia's largest drilling company, and is also working in Egypt, Iran and Oman and has the firm intention to strengthen its leading position and expand its activities throughout the former Soviet Union's territory. Performing 15% to 20% of the Russian Federation's inland drilling today, EDC is poised to remain a very key player in the years ahead. Yet, many members of the service community still perceive the company as a Lukoil subsidiary, casting doubts on the self-proclaimed independence of the operator. Whether EDC will perform as a regular market player governed by the laws of competition and fair business or if it will benefit from a cozy captive market with its former mother house is anyone's guess. Teaming competencies Meanwhile, the sheer size of the industry has attracted a set of other interesting players. Looking to build a position in drilling and oilfield services, Integra is a new generation of player. Backed by Western private capital, the company acts as a holding, with a view to purchasing service assets across Russia, and now encompasses drilling, workover and geophysical activities after purchases in Western Siberia and the Komi region. "With 40% of the market serviced by small and midsize companies, the potential for horizontal and vertical growth is large," says Felix Lubashevsky, Integra's chief executive. "My belief is that we are at the beginning of a consolidation movement that will extract seven to 10 players that will be a mix of majors' subsidiaries, foreign players and independent players controlling up to 70% of the market." For Integra, the largest areas of growth in the years ahead will be Eastern Siberia, South Tyumen and the Yamal province, he says. In this case, the real challenge is managing a smooth development and the coordination of very different assets gathered in one ad hoc structure. This model was also followed, yet on a smaller scale, by Petroservices, another gathering of various companies under a single roof. Manufacturer and supplier of downhole equipment, the group also produces hydrodynamic research tools, carries out monitoring and measurement services for drilling, including hydrosounding, as well as activities in pipeline-flow measurement, IT and other services. Petroservices presents a convincing profile for foreign companies willing to enter the Russian Federation's market and use an existing vehicle to develop activities or find a partner. "Our first aim was to get together operations that would not have gone far on a stand-alone basis," says Mikhail Damaskin, Petroservices general director. "We can now centralize their marketing, sourcing, and sales efforts and concentrate on building synergies. All these things these companies might not have achieved by themselves." Indeed, in a country where companies have been used to deal with in-house services, convincing them to call upon external companies isn't necessarily easy, so one has to display strong credentials to become a recognized contender. With service contracts usually signed for periods of one year, pressure weighs heavily on the shoulders of service contractors who have to renew their lifelines every year and face the threat of permanently losing their contracts. For drilling contractors, the competitive threat can take unexpected shapes: major global players like KCA Deutag and Weatherford are already present in the Russian Federation, pulling the sector upwards as far as quality and diversified service approaches are concerned. The new threat is now emerging from the east: Chinese drillers have already started to penetrate the market in Eastern Siberia and the phenomenon is expected to grow in the years ahead. "This is taken seriously by most of the actors of the sector," says the senior manager of a leading service contractor. "This is why we are strengthening our operational and corporate structures, so we are able to approach our clients with critical mass, alongside solid services and offers. As most of the operators won't be able to engage in a price competition for long, the threat has to be addressed through quality and privileged partnerships with the upstream players." As a result, companies like IDS (Intellect Drilling Service) have appeared. Made up of experienced drilling specialists, IDS is an engineering and service center looking at extracting and maximizing customer value from the extensive Soviet and Russian experience in drilling. "We have to work on changing mentalities besides improving our clients' bottom lines and striving to improve the overall quality level of this industry's drilling activities," says Alexey Messer, IDS general director. "The sector is still reacting slowly to new products and services available to improve operational results." Through increased competition and changed market expectations, a rush for recognition has begun for those who don't benefit from protected markets inherited from the past. Former giants Recognized service players in the Russian Federation include those in place for many years. In engineering, procurement and construction (EPC), the uncontested leader is Stroytransgas, a giant player, directly descended from the MinNefteGazStroy, the Soviet ministry of oil and gas construction. Turning over more than $1 billion, with 20,000 workers, the group specializes in pipe engineering and construction, such as power stations, compression stations, development and operation of oil and gas fields, and civil engineering. The company has built large chunks of the Russian-region pipeline infrastructure and worked on large international projects like Blue Stream that brings Russian gas to Turkey through a 396-kilometer pipeline, partially running under the deep waters of the Black Sea and the deepest pipeline project ever achieved. The company also set world records of productivity in this project, and displayed a breadth of know-how, from micro-tunneling to the laying of a critical gas infrastructure in a seismic region. Stroytransgas has also been involved in projects in Greece, Finland, Algeria, India and Kazakhstan. Currently the company is building pipelines in Sudan and India and recently won a new EPC contract in Algeria. Despite being the direct descendant of a state-controlled structure and notwithstanding its sheer size, Stroytransgaz displays a very modern front, has streamlined its business, separating units and establishing subsidiaries to gain efficiency points, and is constantly looking at ways to be best-in-class. Alexander Lavrentiev, vice president and head of strategic management, says, "Selecting between the different ways to develop ourselves is not a threat or a difficulty but an opportunity to open new prospects. The main difficulty in Russia is linked to the development of market relations. The biggest Russian client still has attitudes that are different from normal international practice. "Normally, the client divests and outsources EPC. But here, some Russian clients think it is better to spend money inside the company than outside. International practice has shown that only in very stable administrative systems this approach could be imposed. At Stroytransgaz, with extensive international experience working on a pure EPC basis for Bota, Sonatrach and other clients, we believe that market drivers will push Russian clients into more market-orientated approaches." Educating the market is therefore another task taken by Russian service players when trying to tap into the 70% of services still completed in-house. Bringing in the latest technologies and using capital-intensive techniques to maximize the use of an asset or the quality of infrastructure is now becoming accepted as common practice. Much work remains to be done on shifting business paradigms and organizational habits, from a vertical approach, where total control over a project is the norm, to subcontracting and the use of modern appropriate instruments. "Stroytransgaz accepts construction contracts," Lavrentiev says. "It also accepts EPC contracts. We had to construct the whole chain of these competencies. Now we are working on our processes to see which link needs to be strengthened. We have found out that we have to develop our engineering companies and project-management capabilities. We learned a lot from large international players and American corporations to see how they organize themselves and we see now that we still have opportunities to structure ourselves in a way that could be more efficient." From a rigid structure and frame of activities, companies like Stroytransgaz have learned to radically change their profiles, and to adapt more precisely to their environment. They became key global contenders in very short periods of time and are more eager than ever to reap the benefits of their visions. Russia is looking at building one of the world's largest oil pipelines, connecting Western and Eastern Siberia with the Pacific. It is also involved with the biggest gas production and transmission project in the world-connecting the Yamal-Nenetski province to Europe through the Baltic region (already Stroytransgaz was involved in the construction of a gas pipeline connecting Yamal to Europe via Belarus), as well as some possible interconnection between the Russian grid and Asian and European markets. In other words, the future is bright for the few Russian mega-players that have managed the transition from state administrations to fully recognized international players, displaying know-how, competitiveness and an appetite for global growth. Vertical and horizontal Other large players have developed through both vertical and horizontal growth. One example is MNP, a group owned by OMZ, a Russian steel concern. MNP has gathered shipbuilding activities (at five shipyards) with ship machine building, drilling tools and drilling equipment divisions and a strong heavy offshore design and fabrication capability. This is in part due to the acquisition of U.S. offshore design and engineering company Friede Goldman. Michael Kosslapov, MNP president and chief executive, says, "The market is slow for heavy land rigs these days." Competition from the East is increasing and becoming a source for concern. "We have to be wary of the Chinese competition in this segment, with players like Baoji that are stepping up their presence in this market. For our group, we foresee growth potential in smaller land drilling rigs like modular cluster rigs." As for the rest of MNP's business, offshore design today represents 15% of total activities and could well go up, with Caspian projects providing the bulk of this growth momentum. The company already participated in the construction of equipment dedicated to Kazakhstan's offshore fields, notably for Italy's Saipem. A large integrated player like MNP-benefiting upstream from metal supplies from its mother company, midstream from fabrication yards and shipyards, and downstream from a wide array of subsidiaries-still needs to work hard on its strategy to face competition and maximize its own growth potential. In the case of its drilling equipment activity, the opening of service centers is expected to provide the differentiation necessary to cope with Western and Chinese competition. Niche excellence After being cast in the shadows of unforgiving international competition, local equipment makers are seeing light at the end of their tunnel. Such a significant player is Volgaburmash, the country's leading maker of drilling equipment, and one of the world's largest producers of rotary drillbits. After difficult years, the company successfully restructured itself and expanded marketing efforts into Asia, the Middle and the Far East, North and South America, Africa and Australia. Meanwhile, it upgraded its production tool and expanded the range of its products, today offering 350 different bits, from three to 26 inches. "We were successful in coming to terms with our past and efficiently shape our present," says Michail Gavrilenko, Volgaburmash president. "And today, we have learned to forget about having complexes on our products: after serious efforts and capital expenditures, our quality and our services can today rival on the global stage. Our past in unrivalled and we are working hard to make our future the same." Despite the optimism, Gavrilenko worries over the purchasing policies of Russia's large upstream players. "Nobody knows what they buy, to whom and for what prices," he says. In the shadows of the large groups, smaller players also try to find a place in the sun, and here again, offer reasonable opportunities of investment and cooperation. The Soviet Union's tradition for scientific excellence has left behind a plethora of highly qualified technicians and engineers eager to embrace opportunities. A wealth of entrepreneurs and bright minds has established small businesses, sometimes one-man shows based upon a single technical innovation. A decade on, and some of these players are still around, some thriving, others striving to move to the next phase. The cutting edge of their products and services deserve attention from the oil and gas investment community, but Igor Melnikov, chairman and president of Petroservices, draws limits to foreign investors willing to step in the service industry. "We are very happy to see foreign companies coming and bringing their know-how and technologies and establishing joint ventures in Russia," he says. "On the other hand, we don't want to see too many companies coming to Russia only to purchase assets." He adds, "We want transparent investment to come to the Russian service sector. We don't like monopolies; we want a fair, open and competitive environment." Examples of local exciting players abound. Geokosmos creates and supplies 3-D terrain and engineering structures models and large-scale digital topographic maps, allowing the precise 3-D visualization of terrain as well as structures over it, even complicated ones like oil and gas treatment plants. Meanwhie, Geophysical Data Systems (GDS) is a seismic-data-processing software developer established 13 years ago. Its Interactive Statics Technology product allows quick and easy processing of data, notably in difficult terrain. GDS has also worked with major clients in the Gulf and in the CIS region. Yet the Russian market seems to be ample enough for Alexander Zhukov, managing director. "A few years back, we were actively seeking customers around the world-in Canada, Saudi Arabia and others-but since then, the volume of work with Russia has picked up, and has provided us with enough work to keep our company and our people totally busy," he says. "Today, with the announced conversion of exploration licenses into production licenses, we see a good stimulant for the development of exploration activities, and for our products." Another example of technical excellence is INEF, a Moscow firm that has developed equipment and techniques for the acoustic rehabilitation of wells and beds, allowing increased yields from boreholes previously partially clogged. The company has recorded commercial successes in Russia and in the Caspian region, increasing yield in up to 1,500 wells in more than 50 fields both in Russia and abroad, producing in excess of 2.5 million tons of additional oil from wells that were suffering structural damage. Building on these successes, INEF is now looking at other opportunities to expand its sales and to invite an investor to give it a second breath of life at a time when depleted fields, old oil wells and damaged structures are boosting commercial value more than ever across the former Soviet Union and beyond. "Our technology will be very popular tomorrow with small and medium-size companies, as it is cheap, easy to deploy and produces fast results," says Isaak Orentlikherman, INEF chief executive. "We are ready to collaborate with possible partners, as we believe this technology has a strong commercial future." Growth potential This example illustrates the sort of potential still to be revealed by the Russian service sector, from the largest players to the smallest, offering niche investment and other forms of partnerships opportunities. With only 30% of the sector to be considered as "open" generating up to $3.5 billion of revenue, the potential for future growth is enormous and the appetite for development by local companies is real, and today more than ever built on solid credentials. The sector also remains firmly anchored at the heart of a major hydrocarbon region, also promising plenty of future developments provided Eastern Siberia, the Arctic North and the most promising parts of the Russian shelf keep their promise. The balance of activity development should be provided by the use of enhanced-oil-recovery techniques and the unrivalled construction of groundbreaking infrastructures like the giant pipelines being planned. For those lucky enough to service this growth, the sky will be the limit.