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The shelf obliges

Yuri K. Shafranik, one of the foremost domestic authorities in oil and gas industry, Chairman of the Union of Oil and Gas Producers of Russia, Head of the Russian Chamber of Commerce’s Committee on Energy Strategy and Fuel & Energy Sector Development, reflects on the problems of Russian shelf development and the challenges to be met by domestic shipbuilding industry in this context in an exclusive interview with United Shipbuilding Corporation’s corporate magazine.

-The oil and gas sector of the economy is the main contributor to Russia’s budget. Moreover, in 2008 the export of oil literally saved the country from economic collapse. And now we are eager to produce hydrocarbons on the Arctic and Far Eastern shelf, while more than 80 percent of undiscovered deposits are accounted for by land. How much is advisable to go to the shelf? Maybe it’s better to leave it alone and just increase the oil recovery factor (ORF) in order to keep on producing about 500 million tons of this raw material a year?

— You cannot oppose one another. And the point is not just the ORF. Exploration and development of any oil and gas provinces require a systematic approach, a precise determination — what project and when you need to take up, what objectives need to be set and for whom, what conditions need to be created to attract investors and project contractors. Moreover, the energy policy, including taxation, should accommodate the full range of geographic and economic differences observed from Kaliningrad to Anadyr. By the way, there are no two shelves alike: the Arctic environment differs strikingly from the Caspian, Azov or Black Seas…

Yes, the oil industry has saved the country when the economic crisis struck. And everyone should always remember this. But it is more important to all of us to understand and have a firm grasp of how this industry was created, what successes the oilfield workers achieved in an incredibly short time by overcoming any difficulties. It is important to remember this in order not to be afraid of serious work today… Back in the early 1970s, my oil executives confidently showed dense taiga regions around the village of Langepas on the map: “By the next winter, ten drilling sites will be here, and twenty — there…”

Then, such plans seemed unthinkable to me, a young specialist. However, all the scheduled sites really quickly emerged, failure to meet the schedules was always insignificant and caused by force majeure. Moreover, machinery and equipment — except for large gas compressors — were then exclusively domestically made. Even now, in my home town of Langepas, the share of operating import equipment does not exceed 10 percent. Everything else is Soviet-made equipment that still works reliably (of course, after some modifications).

The results depend on goal-setting. In the 1930s, domestic industry was created by people who, in fact, were just torn from the plow. They had to quickly learn specific skills from our own and foreign experts, because specific tasks were set — to build a car, a plane, a ship or a blast furnace …And every task was described in detail specifying who performs it and how, in what time frame, what we buy abroad and what we make ourselves, etc. It was then (in the 1930s and 1940s) that the creative chain “Idea — Research Institute — Design Bureau — Pilot Production — Embodiment of the Idea” emerged. And then the construction of a plant began for mass production of those products in which there was a need.

Of course, the scales are different now than they were before, because, after all, we are now equipped with new knowledge, techniques and technologies. However, as regards goal-setting, not everything is in order in our country unlike those times. Many may fairly note that in the industrialization period the goals were often achieved by improper means. OK, let’s now fully apply proper means — market means creating a competitive environment. By the way, the Trans-Siberian Railway — the longest railway in the world — was built in tsarist Russia times in a record short time without the use of forced labor. For many years I have not got tired of repeating that the main tasks for the oil and gas industry are to increase the efficiency of subsoil use by extractive industry companies and improve the operating performance of the companies themselves several times. It is necessary to give accurate performance evaluations and accordingly modify the economic policy on their basis. If we don’t do this, we’ll continue to parasite on the productive capacity laid before the birth of the Russian Federation and so the industrial property handed out in the 1990s will wear down to the last hole instead of its development and growth.

Of course, this is profitable to a small circle of persons preferring to invest only in their own welfare, but is detrimental to the country. I recall that the global stock market on the eve of the 2008 crisis was estimated at US$ 60 trillion, and our market made up more than US$ 2 trillion of the amount. Then, the global stock market fell 1.8 times, the Russian one — more than three times, while the capitalization, for example, of Gazprom dropped more than five times at all. It is impossible not to think about this — though indirect but real and tough — assessment of the level of management efficiency of our companies. A lot of efforts and resources are not needed to change the situation, it is necessary only to show greater political will and pose stricter requirements for performance of companies’ management. Now we’re already ten rather than five years away from developing the hydrocarbon deposits of the “Eastern Vector.” The Eastern Siberia-Pacific Ocean (ESPO) oil pipeline has been laid and the State has built a fairly extensive infrastructure along it, whereas oil reserves needed to fill the pipe were insufficient earlier and have not been added so far. One can talk about mere cake crumbs. Also, gas reserves have not been added and new deposits have not been developed there. The Vankor deposit saves the situation, although geographically it in no way gravitates toward the “Eastern Vector” and feeds oil to the ESPO along a “knee” route through the Tyumen land. Only Surgutneftegaz, Irkutsk Oil Company and Dulisma operate along the ESPO. As regards the latter, Sberbank should be thanked: it has pulled the company out of a difficult financial situation and ensured the normal operation in the field. Nevertheless, there is still a great deal to do in terms of hydrocarbon pantry development.

— What is the reason for lagging behind over many years? It is very important to understand because the problems in the Arctic would be far greater.

— First of all, this is due to insufficient drilling activities. Moreover, no necessary increase is expected both this and next year. Commercial crude oil production has been carried out in Russia for 143 years and always the matter “got stuck on well.” Oil comes only from the end of the bit. And today even our exploration efforts are insignificant: 2 to 3 wells in the exploration area. In general, the amount of exploratory drilling had declined from almost 2 million linear drilling meters in 2001 to 1,170,000 meters in 2011. To provide enhanced growth of oil reserves, we need to increase the amount of drilling 2.5–3 times.

— What is to be done?

— We have to work properly — improve the performance efficiency of companies and seek to achieve a high ORF. There is no need to refer to a deterioration of the resource base, which shrinks in all producing regions of the world. Note: this deterioration causes some to lose their previous positions and helps others to gain position and expand their presence in the global oil and gas market. Texas, second oldest oil region of the world after Pennsylvania, is a good example. Over the last 5 to 6 years, without discovering giant fields like our Samotlor, Texas has almost doubled its oil production. Owing to thousands of small oil fields and small companies, oil production there has grown from 50 million to 100 million tons. Moreover, the cost of gas for industrial enterprises in the same period has “dropped” from US$ 212 to US$ 90 per thousand cubic meters. Imagine what a strong economic momentum Texas has got in just a few years! And what, is it a wonder? Of course, it’s not. This is a natural result of targeted, coordinated efforts undertaken by the federal and regional authorities, taking into account global trends that are already obvious or predicted only… A high efficiency makes the production of 100 liters of oil per day profitable here, whereas in our conditions even 5 tons do not fit into the profit limits.

— You see, this means that we must put things right on land rather than strive for the shelf?

— All the above does not cancel the Arctic. It also requires the consistent steps in development but different from what we do, for example, with respect to the Shtokman gas and condensate field, one of the world’s largest deposits. Its development plans were ready 10 years ago, and now they say that the work at it will not start before 2019. Apart from the “hung” Stockman project, we have good experience with the Sakhalin‑1 and Sakhalin‑2 projects, which were initially created in more complex water and ice conditions than in the Barents Sea. Launched in the 1990s, these projects are still in successful operation. But we need to refine: they were initiated by the State, which created all conditions for companies to operate actively.

Of course, there were problems along the way (they are typical of all large projects), but the State also solved them. No one can foresee everything in detail for the years ahead and describe everything in the documents perfectly and forever, while the projects must be launched without swinging. If conflicts arise between the sides, it is necessary to sit down at the negotiating table. It is obvious that the State has received, is receiving and will receive a lot from the Sakhalin projects. And most importantly, the island has been given a new breath of life and the people living there have received an incentive and the means of livelihood. If the “fine tuning” process takes years, the result would be similar to the Shtokman case.

By the way, all that happened also because of the weakness of our analytical services destined to keep track of the priority trends in global oil and gas industry and recommend the most promising projects for implementation. For example, we have missed the shale gas revolution in the U. S., although it did not occur in one day and its preparations took several years. But believe me: there is no particular trouble that the Stockman project failed to start. We have other gas and gas-condensate deposits in abundance. Moreover, in projects of such a scale one cannot rely solely on the volume of hydrocarbons. It is important to use domestic productive capacity to maximum and ensure the adaptation of advanced foreign technologies. It should be clearly determine what companies manufacture the appropriate equipment and when, arrange the order of their advancing.

The implementation of offshore projects involves, first of all, the development and improvement of the technological capabilities required for offshore and underwater production. This will require radical modernization of many companies in the North-West and Russia as a whole. And the initial idea to liquefy the gas and ship it to America was, frankly, too small, it did not take into account the market development, although in the oil and gas matters we have to look forward to a quarter-century. If the Stockman field is considered as just another hydrocarbon reservoir, then we will certainly pour the funds found to develop it into the economy of the West by purchasing equipment and technology there. In this case, where will we supply gas? To the West again. And will settle the loans for another twenty years. What will Russia get eventually? Mythical experience in developing hard to- reach nature storerooms? To gain real experience, it is better and easier to send our specialists for a few months to intern at foreign terminals and platforms.

— What conclusions can be drawn from experience available to us and other countries?

— The shelf, especially the Arctic shelf, is the area of state interests and the area of state responsibility, both political and economic — responsibility for the environment, for the inviolability of borders. And who will be responsible for accidents that are more dangerous there than on land? What company will cope with a serious accident at sea? BP would not have coped with the disaster in the Gulf of Mexico alone! Only the state can. Of course, using companies, Ministry of Emergencies, mobilizing professionals and attracting volunteers, but — the state. It defines a control system and standardizes the operational environment for companies. Meanwhile, with all the state interest, one cannot rely on the success achieved using public money. It is much more important to ensure the favorable project implementation conditions, loading of Russian industrial enterprises, minimum investment of public funds along with the maximum direct investments of non-state entities. Here it is possible to attract large international companies, international financial institutions (from pension funds to investment funds), because the companies use not only their own money. By the example of the Sakhalin projects, one can argue about whether it is worth trusting a whole shelf to one state-owned company, but in any case it would be right to specify the license development blocks for it and identify worthy companies for all the key positions on a tender basis.

This will allow Russia to stake out several offshore sectors as outposts. Literally, 3–5 key sectors verified in every sense (to left — in the North West, to the right — in the East, close to Chukotka, and 1–2 sectors closer to the Pole). But it is important to act systemically at these outposts, too, by increasing industrial production of own platforms and developing domestic shipbuilding industry in parallel, and take the condition that at least 70 percent of equipment should be locally manufactured. The personnel for this, although not many, still exist — veterans and young professionals who came into the profession by calling.

— In your opinion, what form of management for such projects is most effective in the Russian context?

‒ State-owned companies operating offshore have to go to multilateral consortia, to a format that prevents possible abuse, makes it possible to work actively with partners and efficiently cooperate with investors. As is known, the easiest way is to steal alone. When working in tandem, it is always possible to agree between each other. But when working in a consortium comprising three members, it will be difficult to agree and steal. And Western partners will feel more comfortable, because they appreciate this format and know how to operate within it. As is known, the Dutch were the first to create public companies, because every merchant was afraid to take risks with investing in one ship. They gathered together and built 10 ships. The ships went into the sea, some came back with the goods, and the others were drowned or robbed by pirates. Nevertheless, the consortium always won. A similar story is with the shelf. And there is nothing fearful in today’s offshore development projects! Their main feature is a giant scale, the enormity of the tasks, costs and associated problems.

And most importantly, when you are a member of a consortium, you will always know that under the terms of the contract you have to use Russian equipment — for example, place an order for a platform with Russian plants. And if a plant is not yet capable of doing this, then you will solve the task in general, including the subtask of solving the plant’s problems with the plant management. I repeat once again, there is nothing fearful with that. It is important that the conditions are created so that the plant starts to operate. It is critical to find partners because the partners bring technologies. From the investor’s standpoint, money can always be found for a good project (given worthy terms). For example, the Algerian state company Sonatrach works fine — it produces, processes, and transports oil and gas. It ranks 14th among the oil companies in the world. It pays great attention to gas liquefaction technologies and became the third company in the world in LNG transportation. Are we worse than Algeria?

— Why do we have so few consortia in the country?

There is a quite reasonable answer to the question: one of the key factors in the consortium format is as few kickbacks as possible. Yes, corruption is Russia’s disaster, but I cannot agree with the fact that the Russian people are a priori corrupt. The vast majority of the Russians are strong opponents of bribery and, more specifically, government corruption.

— Who should lead the shelf activities and at what level?

Since the shelf development is a national task, the coordinator should be a person of State, who will lead the program as a representative of Russia’s legitimate interests. As to the level and structure, these are the organizational issues. It is possible to set up a ministry and appoint the minister or a deputy prime minister a responsible person…

— Do you think are there Western partners willing to take on the potential risks of long-term offshore projects and actually promote the growth of our industry?

If the State creates favorable conditions,such companies will be certainlyfound! As you know, I run a companycarrying out oil and gas projects in nearlya dozen countries around the world.And wherever I came to, whoever I met,we always discussed a specific projectand the specific environment in whichwe will have to work. It is paramount,and only then such factors as, for example,the well-known events in Libya, aretaken into account. Therefore, if the conditionsare in place, the Western partnerswill come. Rosneft that signs oneagreement after another and experiencesno problems with attracting partners isa good example. It is critical to maintainthe state vector, state governance control.

— After how many years can we expect returns on the shelf?

We need not wait for anything. A big payoff is already in the starting need for a huge number of high-tech jobs (which, by the way, correlates to the President’s task to bring them up to 25 million). In addition, we will obtain the effect of the accelerated recovery of the Russian industry. In addition, shelf development will increase our research capabilities, especially in the field of geography, geology, and oceanography, and provide the academic institutions with specific, guaranteed orders rather than projects destined to replenish the archive shelves. The same can be applied also to the task set by Vladimir Putin in May for the United Shipbuilding Corporation. It is in establishing closer cooperation between shipbuilders, Gazprom, Rosneft and other companies whose activities are somehow related to operation of marine equipment — in particular, equipment for hydrocarbon exploration and production on the shelf. But here we need to understand that the main goal of the next 15–20 years is large-scale development of the whole offshore production facilities and not getting tons of oil or cubic meters of gas.

Therefore, customers (beginning from the government customers) — all companies of any form of activity and ownership, interested in specific offshore projects, in the relevant technologies and equipment — have to start first. It is important to clearly define the main objectives for all participants of the “Big Arctic Game” today and not in 15–20 years, so that to determine the contours of the unprecedented mega project as soon as possible. And relying on these contours, it is necessary to choose contractors, organize consortia with the mandatory participation of foreign partners and sources of funding without delay.

As a result, for example, shipbuilders or machine-builders will not have to wait in vain for investment and will start work on the orders as soon as possible. And then, already in the near term, the future tons and cubic meters of hydrocarbons will turn into an industrial and economic boom, which, by the way, will save us in the foreseeable future also from having to purchase foreign equipment and technology the oil and gas industry.

What else do you think should be taken into account when launching large-scale offshore projects?

The shelf development program cannot be implemented without the bases, without reference (support) points on the coast. We have Salehard, Norilsk, Dudinka, Dixon — it is necessary to start developing the coast around them and work on the shelf in parallel. We need to develop the infrastructure in these cities, because flights to the platform will be made from them rather than from Moscow. There is another important point in the sequence of offshore development efforts — exploration. Exploration along the Arctic coast in the belt of 200– 300 km. It is necessary to think about it today. You cannot just put out to sea — there is ice. So, as I said, we need to define reference points in order to stake the whole “areal” of deposits and conduct exploration along the coast. Today a target and urgent exploration program is critical more than ever and it must begin from the coastal points. In this context, I would like to recall one strategic area of activities, fundamental to the success on the shelf, which attracts attention today, but it seems to me the efforts are not sufficient. It is geology, geography and oceanography based on academic science. We descended the bathyscaphes at the North Pole, planted a Russia’s flag on the bottom of the Arctic Ocean, but the time has come long to fundamentally study Arctic geology, shelf geography.

This must be done thoroughly, at the academic level with the use of innovative methods and techniques, and not just for the sake of deposit exploration. It is important to remember an approach that has always distinguished Russia — fundamental, consistent, meticulous academic research of the Arctic area, mineral resources and the processes occurring there. It is important to formulate a government request for the systemic accumulation of knowledge that will surely transform into the quality of scientific discoveries and will create favorable conditions for the success of the Russians’ activities in the Arctic in all directions, including the defense area. It is time to define the ranking of priorities for this problem, discuss them, appoint the responsible persons from academic and economic circles, assign the timing of implementation — and all will move! Moreover, work is already under way: the good foundation has been laid by studies carried out by the Institute of Earth Cryosphere, Siberian Branch of the Russian Academy of Sciences; international science conferences are held at the highest level in Salekhard (the city is gradually becoming a mature subject of Arctic facility development with the support from Governor of the Yamal-Nenets Autonomous Area Dmitry N. Kobylkin and a major contribution of the scientific community, including Academician Vladimir P. Melnikov). A promising research base with its center in Tyumen and a branch in Salekhard is being developed, which opens the opportunity of practical studies of such significant Arctic themes as permafrost ology, sea glaciology etc.

— But these research studies are possible if there are projects that need them. And if there is no project, there is no work, you’re saying so?

This is not exactly the case. The State itself should initiate research studies. The latter will require no much money, no billions of dollars. To resume the general shelf studies, a hundred million dollars is enough, and then the blocks, addresses, programs, projects, and the terms for participation of companies are defined (for deeper and more detailed studies).

— It turns out that the basic points of the offshore projects and academic activities will be integrated with the NSR development and support points?

Of course, these points will involuntarily coincide. I have already talked about the need to competently revive the bases. Just remember when domesticating the North our ancestors tied this process to something: reasonable logic has always been present at the junction of geography and economy. This logic, I’m sure, will cover many of the current projects in the already existing city bases.

— In the recent two or three years, there has been growing resistance of international environmental organizations to Arctic shelf development activities that began. The things came to an intrusion of the activists into offshore platforms (Prirazlomnaya oil platform) and support vessels. Do you associate such an activity with a real concern for the fragile Arctic environment or admit that the real reasons may be different, including political reasons?

— A combination of both the aspects is almost always present in the situations like this. It seems to me, the environmental movement consists mostly of people who worry about the future of the Earth. The longer I live, the more I reflect on this. At the same time, both the competitive and perhaps even political factors are present in the Arctic actions of the environmentalists. It is sufficient to wonder why these people are not engaged in the Caspian Sea with the same passion, because environmentally this area is not less vulnerable. Potential problems, and most importantly, their effects in the Caspian Sea can be much more dangerous than in the Arctic. The Caspian Sea is a closed ecosystem and there are major reserves of sturgeons. Vast areas of the Caspian Sea have a depth of no more than 5 meters. If, God forbid, oil spills at such depths, one has to forget about sturgeons. However, there is no such activity of environmentalists in the Caspian Sea region as in the Arctic.

Therefore, I see the trinity in the environmental

movement: competition, politics and sincere feelings of people. I think if the protest is sincere — we need to work with environmentalists, take into account their constructive ideas and concerns to the utmost. We have no right to make mistakes. But when Russia’s rivals clearly act as the driving force of the protest in order to torpedo or slow down the development of our major projects, we must respond in a different manner.

— In the 1990s, the revenues received from hydrocarbons and redistributed by the State helped it somehow solve the problems of economic and social survival in an unusual market environment. However, the development models of the gas and oil industries turned out to be different. Which of them has demonstrated greater effectiveness?

— In those years, the Soviet Union ceased to exist as a state, most of enterprises were privatized, its industrial giants were split into parts (for example, Uralmash, one of the largest companies in the country, disintegrated into 20 Uralmash shops). But we were then able to ensure the formation of vertically integrated companies in the oil & gas sector and the transformation of the head management entities of oil & gas holdings into the real profit and responsibility centers (the transformation of the Rosneft state-owned enterprise into a public company is an example). In addition, we initiated the inter-branch integration, the emergence of the Federal Law “On Subsoil” and a number of government regulations that generally defined a special path of reforming the fuel & energy sector.

If the reform of the aircraft, shipbuilding, machine building, and electric power industries since the beginning of the 1990s went in this manner, the entire Russian economy would be innovative and competitive today. But I’d like to draw attention to the fact that it is necessary to separate reform from privatization. Privatization is a political decision, the distribution of property or the creation of a class of owners. This is not reform. Unlike that, we have reformed the oil and gas industry.

— Can we call the lack of market, direct administration, and political will the key to success of oil and gas projects in the Soviet period?

— In Soviet times, the industry also lived by market laws. In the mid‑1970s, a ton of oil at Samotlor was worth 1 ruble 50 kopecks, whereas it was sold abroad for currency — the barrel was sold at an average of US$ 20. So a huge market already functioned at that time. Major projects, primarily investment ones, are extremely beneficial in all their forms, while how they are arranged (through a state structure, through state planning) is another issue, an administrative affair.

— Let’s get back to the events of the time: who has “frozen” Stockman?

—The postponement of the Shtokman field development is a decision made by Gazprom, a corporate decision, and it is not even a decision made by the state.

— Maybe it would be better to entrust a private company with such a project?

— Many people say that private companies are more efficient …A private store — yes, more efficient, a private restaurant — more efficient. For a company employing more than 100,000 people, it doesn’t matter, whether it is public or private. In large companies, the professional level of management, the nature of goal-setting, clear objective setting, mobilization of employees are of paramount importance. Performance efficiency is ensured by these parameters. Incidentally, the undisputed advantages of private companies are usually maintained by either those who are striving for the next carve-up of national (or already private) wealth or people who do not understand the essence of corporate governance. It’s another matter that over many years of new economic relations we have failed to establish national institutions that really affect the companies’ activities. We are trying to identify something: think, write, argue, design …Possibly, we just had not enough time: did we assume in 1991 what our economy would look today?

Of course, it is easier to “bless” a state-owned company from above with the implementation of any project. But, again, the result will depend on the level of competence and responsibility of management, which necessarily implies informing the political leadership timely and truthfully about the situation in the “entrusted section” and the presence of creative skills to develop solutions to any problems, as well as the ability to solve problems independently and effectively.

For example, in recent years totally non-private Rosneft has significantly increased the efficiency of work in the Yugansk deposit region. Today, all the service companies operate there more efficiently than before, production costs are reduced. As a result, the company itself and our economy as a whole are the winner. And it is no secret that many private companies are far behind Rosneft in performance efficiency. By the way, in the West, one company takes over another precisely because it is more efficient. Because of this, many companies valued even at US$ 10 billion die. And billion-dollar enterprises grow like mushrooms after the rain, but disappear very quickly sometimes, too.

— Some time ago renewable energy projects started as an alternative to hydrocarbon fuels and now they are on the brink of the abyss in Europe. What is your prediction for their future?

—The current situation is a good example, a good comment on the thesis that everything in the West `is decided correctly. No! Everyone has the right to make a mistake. Although we warned that the real alternative to hydrocarbons is a matter for the future. I’m, too, for alternative energy sources and also want a clean environment and eco-friendly equipment. But when you consider that this is a subsidized project, the state has to decide where the money should be taken from to implement and support of this project — from the pension fund, the social sphere…

— Finally: How do you assess our industry’s capabilities to develop the technology necessary for full-fledged operation on the shelf?

—What can I say: if there are no technologies, it is necessary to develop them and adapt foreign advances through our companies? For me, the “Chinese Wonder,” encouraged largely by the example of the Soviet Union, is an example. I’m talking about the results rather than methods. We launched the first satellite and built the most powerful nuclear industry as early as the 1950s. And what have we created at the end of the 20thcentury? What new have we done for Russia for more than 20 years since the beginning of the 1990s?

Once we count what has been done, we’ll see: China is going along the Soviet Union’s road. Aside from the two aspects, which China has clearly taken into account and avoided catastrophic mistakes. First, we socialized all small-scale production and eliminated it, whereas China is developing it both in agriculture and industry. Second, they have not isolated themselves for some reasons (re-assessment of our experience or the historical and geopolitical reasons), while the Soviet Union was in isolation. The Chinese actively went out and go out abroad — they grab markets, work, learn.

I have been often to China. Today the bulk of the population there is still backward, uneducated — and how much they produce! Because they take the best (where they can), adapt and launch in mass production… There are a lot of good work practices abroad and they have a lot to learn from them. But it is even more important to us to refresh our own historical memory and firmer grasp that we are able and must achieve the desired results in a highly competitive global market.