We last spoke with geologist Gerald (Jerry) Walston in June 1992, right after he returned from Western Siberia, where for a year he was director of operations for the White Knights Joint Enterprise, a venture that operated two oil fields with 800 wells and managed 1,300 Russian employees. It was the first oil-development partnership of Russian and American companies. Since then he has held several similar positions in Kazakhstan, Pakistan and Russia. In 2000, he was chief operating officer for Khanty Mansiysk Oil Corp., whose Russian assets were acquired by Marathon Oil Co. in 2005. Today he is director general of a Russian joint venture, GazTex, with Midland-based Mexco Energy Corp. as one of the major partners. Walston says he still sees Western companies making the same mistakes after 15 years and wonders why, so, through consulting firm John S. Herold Inc., he has published a practical book, called Red Oil, in which he shares his lessons learned, offers advice for successful field operations, and explains the Russian way of doing things. Investor-How do E&P companies get around the perception that investing in oil and gas in Russia is just too risky now? Walston-Doing business in any country is risky. Russia certainly has its own set of risks, both above-ground and downhole. Not understanding how their system works is perhaps an obvious risk, yet many companies go there with preconceived ideas of how to operate-often tainted by their experience in other countries. Unfortunately, because the Soviet Union was a centralized economy that existed to a large extent to benefit the military, experience elsewhere is unlikely to transfer effectively to Russia. Investor-Still, despite the negative headlines recently, you believe companies should consider investing in Russian oil and gas projects? Walston-The answer is an unequivocal "yes!" You can definitely make money investing in Russian oil and gas-provided you focus your entire organization on making profits as a corporate strategic objective. All employees need to know that making profits is the sole objective. Unless you make that clear, the organization can go into "drift," just meeting the challenges of day-to-day operations. Your Russian employees can easily be seduced by what is urgent, not what is important for making profits. Investor-How does this translate into day-to-day operations? Walston-First you want to focus on your capital investment because upstream outlays will be the largest portion of your budget and work program, especially in the early years of your project. As one example, I recommend that you use Russian drilling contractors as opposed to importing Western drilling rigs. Investor-Why Russian contractors? Walston-In the White Nights project, we imported three Western rigs. The first one was capable of drilling to 14,000 feet when the reservoir objectives were about 9,000 feet or less. It was a beautiful example of Western technology, freshly painted blue and white. The large camp for the Western drilling crews had a clean dining hall, lots of hot fresh food, a cleaning staff. The rig floor was brightly lit and heated. Next to us, the Russian rig had a spindly aluminum mast and a faded, rusty, desolate appearance. The crews lived in small mobile wagons on rubber tires. They ate unappealing food, often straight from tin cans. There was no camp cleaning staff. Their rig was dark and covered in ice. By coincidence, both rigs started drilling almost on the same day, aiming for the same reservoir at the same depth. Of course, the Russian rig reached total depth first, much to our chagrin and to the glee of the Russians. The moral is that Russian workers have many years of successful experience in the oil patch and they have effective oilfield equipment. Still, one needs to understand the limitations of this equipment and how it needs to be supplemented by Western oilfield services and know-how to obtain optimal results both technically and budgetary. Investor-What kinds of new Western technologies can successfully be used in Russia to enhance field production? Walston-Typically Soviet drilling activity was oriented to overbalanced pressure drilling. This often resulted in occluding or "plugging up" the porosity and permeability in productive reservoirs. Compounding that, there also has been poor cement bonding obtained when setting production casing in the borehole. Finally, often Soviet perforation charges penetrated only a short distance, not fully passing through the drilling fluids' invasion zone. These completion shortfalls can stifle yields and mute production results, versus what the reservoirs could actually produce with slightly underbalanced drilling, good casing cementing, and deep penetrating perforation charges. Investor-What should be the mix of expatriate staff and Russian workers? Walston-Having large expat staffs that rotate on a monthly basis is not only expensive, but with office staff, it is very disruptive. It's like having multiple companies at work on the same project at the same time. Russian oil workers are highly experienced and highly educated. It is safe to say most foreign companies could operate with very few expats in management positions, provided those expats were experienced in working in Russia, and possessed Russian language skills. Investor-What can you tell us about Russian permitting and bureaucracy? Walston-Understanding their approval system and how it affects your timing for operations is absolutely essential. There are set procedures as to how one goes about economically placing an oil or gas field into production. The bureaucracy can be painfully frustrating, but it is navigable. One of the secrets of success is to hire experienced Russian managers and staff, and not rely on unseasoned expatriates. One of the better ways to manage this is to flow-diagram the entire approval process and the timing required for each step. Understanding the limits of Russian technology and how it can be supplemented by Western technologies is part of this issue. In the end, you must focus on maximizing oil and gas production within the limits allowed by the authorities. Finally, the export and/or sales process for your produced hydrocarbons is key to receipt of revenues-and your success! Investor-Isn't there a different way of thinking in Russia? Walston-Yes. When you're negotiating they'll suddenly come up with something out of left field. The older generations that lived under the Communist Party's central planning system certainly have a different mindset than we do in the West. The party demanded strict discipline in a militaristic manner: orders issued as a result of central planning had to be fulfilled. Feedback from workers below on how to improve the process or equipment was not part of the process-only reporting results was expected. Bonuses were paid for over-fulfillment and punishments were a likely result for negative results. This resulted in a harsh attitude towards workers and citizens in general and a complete absence of any collaborative management approach. Investor-Doesn't Russia's legal system need a lot of reform to meet our Western business standards? Walston-Its legal system has developed through a thousand years of dictators and autocrats who had complete control of the country. For most of history the government owned everything, so the legal and accounting systems were devised to control the allocation of assets. Profit-making in the Western sense was not a consideration and civil law as it is known in the West was not necessary. There was no contract law to protect the rights of parties in a business arrangement since the state was the only entity in any business deal. I'm not sure how many businesspeople arriving in Russia are aware of this. However, the demand for legal reform certainly must take this historical background into consideration. "Reforming" a legal system like this is not simple and will take many years. Investors sitting on the sidelines waiting for this reform before they come to Russia might reconsider their position. Investor-What is the Russian fiscal system for operating oil and gas fields? Walston-Russia has a licensing system that extracts value for the state primarily from taxes. Some larger projects, primarily offshore, have production-sharing agreements. A license covers the geographic area of an entire field. If it can be proven that the field extends beyond the license into an unlicensed area, there is a provision that allows the license to be extended to incorporate the field's extension. Development licenses typically have a 20-year term. Investor-How does a company go about finding a project in Russia? Walston-There are several ways. Perhaps the simplest is to find someone with an existing license or field in development that is short of operating cash. You can either buy the entire license or buy in as a joint-venture partner. Another method is to participate in auctions or tenders held by the natural resources ministry for new exploration or development licenses. Typically, in the past, exploration licenses have been for five-year terms and development licenses, 20-year. The problem with the exploration licenses was that you could not be assured that if you discovered a new field, you would be granted a new development license. However, there are 25-year term licenses-a five-year exploration term immediately followed by a 20-year development period. Khanty Mansiysk Oil Corp. (KMOC) bought the assets of a geological association in the early 1990s that had discovered oil fields in Western Siberia but did not have the money to develop them. KMOC brought in the investment funds for development. After a few years of development and increasing the value of these assets, KMOC was acquired by Enterprise Oil. Subsequently, Enterprise was purchased by Shell Oil. Most recently, Marathon purchased the KMOC licenses from Enterprise and is now actively continuing the development program. These were 100% asset acquisitions. Investor-Once you acquire an undeveloped oil and gas field, can you just start drilling or is there some sort of approval process? Walston-It would take a set of flow diagrams and extensive discussion to cover all of the elements, so let's boil it down to two major steps: establish a pilot project, and establish a technological scheme and master plan of construction. A pilot project allows you to initiate appraisal and limited development drilling to test various drilling and completion technologies, well spacing and production rates, among other things. It may have a term of several years, but production under such a plan may be limited to no more than 5% of the field's approved total reserves. Technical data and results from the pilot project are incorporated into the design of the technological scheme and the master plan of construction, which are the below-ground and above-ground main field-development programs. Unless you have one of these two steps approved, you are not allowed to develop an oil or gas field. Investor-You still consider Russia a land of opportunity despite the risks? Walston-Absolutely. Consider that Western Siberia as a single basin is as large as four Texases. Eastern Siberia is as large as six Texases, with several world-class, discovered oil and gas fields. But the basin is not yet in production due to the lack of takeaway infrastructure. There are as many as six equally large offshore basins not yet explored. The potential for oil and gas production in Russia is simply mind-boggling. I think any global investor in the E&P business should take a serious look at Russia.