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Russian Oil and Gas Sector Headed for Major Shakeup

Companies / Oil Companies Dec 09, 2010 - 10:18 AM GMT

By: Money_Morning


Best Financial Markets Analysis ArticleKent Moors, Ph.D. writes: SURGUT CITY, Central Russia – Welcome to Surgut City, about 1,325 miles east of Moscow in the Surgut district, which in turn is the primary area of the Khanty-Mansi Autonomous Region (KMAR).

I am here at the request of the Russian Ministry of Energy, to sit as an outside member on a task force reviewing production options for the next five years.

But the "here" that I referred to is in Siberia – in every sense of the word.

The cold snap I experienced before leaving Moscow has hit Surgut City with a much greater bite. When our government plane landed here at 3 a.m. one recent morning, the temperature had fallen to 35°F below zero. The pilot kept the engine running while we disembarked. Otherwise, the plane's oil lines could freeze.

But there was no need to worry. A heat wave was to hit the next day – pushing temperatures all the way up to minus 3°F.

Because it has created a living area for human beings in a place where Mother Nature doesn't want them, Surgut City is yet another example of Soviet-era planning. Located by the banks of the Ob River, this city has a population almost as large as Pittsburgh, but in a place not designed for human living. Everything here displays the local color – gray. The tundra is permanently frozen, and winter lasts eight months out of the year.

It's such a desolate place, it seems nothing of any consequence could take place here.

But that perception is about as wrong as it could be.

This just happens to be the center of Russia's traditional oil-producing area in Western Siberia (yes, there is an Eastern Siberia, and its climate is even worse). Everything in KMAR is directed to drilling or collecting or processing or transporting oil and gas. This is a higher sulfur content hydrocarbon volume than most of what's in the United States. You can literally smell it in the air – that faint (and sometimes, depending on the wind direction, a not-so-faint) odor of rotten eggs.

The five-year plan I was brought here to help review is a basic element of Russia's modus operandi. Five-year plans have been common in this country since the time of the late Joseph Stalin. But lately, they have become more accurate measurements of actual production and development. But this plan is a particularly important document.

You see, Moscow has energy problems. The main Russian area for oil-and gas-extractions is declining. Actually, "collapsing" would be a better word.

This is a very mature basin and estimated to be dropping in output by 7% a year. Most of the more than 150,000 operating wells are working at less than 35% of peak production.

Something's gotta give.

There is one person I need to talk to, more than anybody else, about where Russia intends to go. Picking his brain is the single most important objective I have in this otherwise unfriendly location.

He's Vladimir Bogdanov, the iconoclastic figure who has served as the president of Surgutneftegaz OAO (PINK: SGTZY) since 1983. It trades thinly as an American Depository Receipt (ADR) in the United States, but is a primary mainstay of the Moscow Stock Exchange.

The company is often referred to simply as Surgut, merely serving to further confuse the distinction among company, region, and city, all of the same name. I always refer to it as SNGS (its Russian exchange stock symbol) to get around this problem.

It is one of the Top Five Russian oil production companies and a decidedly private holding. But there are major reasons why this company is always on industry peoples' radars in Russia. It has zero debt and cash on hand approaching $30 billion. It could buy out the government-controlled majors and still have money left.

This means the SNGS president's opinion carries far more weight in this country than you might think.

Bogdanov is also something of a rarity in this business. Prime Minister Vladimir Putin (a close personal friend of his) chided Bogdanov recently, in a good-natured sort of way, for his lifestyle. Unlike the high flyers running other Russian oil majors, Bogdanov drives a used (Russian!) car, lives in a modest flat (in Surgut City, no less), and belongs to no private clubs.

Yet the Kremlin has regularly used SNGS coffers to collateralize deals for Rosneft OAO (PINK: RNFTF), the dominant state-controlled oil company, and Gazprom OAO (PINK: OGZPY), Russia's largest company and the biggest natural gas producer on earth. As a result, SNGS is the Russian private company with the greatest direct access to planning circles.

Another reason to seek his advice...

Significant Moves in Russian Oil
We meet in a small restaurant off what passes for the major avenue in town. The only other people there are his security team – a necessity for the heads of major companies in Russia.

I start by asking him how the Hungarian sale is going. SNGS had bought a position in Hungarian state oil-and-gas company MOL from Austrian state major OMV a while back, and Budapest didn't like it. SNGS has been trying to extricate itself from the deal ever since.

Things are moving along there slowly, he says, without much conviction.

This had been one of the first big foreign purchases for what has been a very Russian operation; the difficulties have served as a rapid education for Bogdanov on the politics of European acquisitions. But the company is also moving into development operations in Iraq and Syria, so its days of being a Russian-only producer are drawing to a close.

Good thing, too.

SNGS has been profiting from the oldest fields in the oldest drilling region. As the production begins to accelerate downward, this company will be hit first. Now, Bogdanov has always operated a tight ship, despite SNGS running the best salary programs in the country and holding a record of not laying people off to balance books. (Having a war chest so large has other advantages, it seems.)

But the SNGS president has something else on his mind today. And what we discuss next is going to be of major importance to investors.

Bogdanov tells me SNGS is still going to expand oil projects abroad, but is now rapidly ramping up natural gas production inside Russia, especially with plans to move into the very northern (and very hostile) Arctic region of the Yamal Peninsula. SNGS will also be swapping production expected over the next several years for export access – meaning that a portion of that gas is bound for other countries. It already has a major liquefied natural gas (LNG) project in the works, and that will be exclusively for export.

He pauses to test my reaction, and I delay my response. This is a kind of game. Move too quickly, and I telegraph my primary interest. Wait too long, and I run the risk of signaling indifference or a lack of understanding.

I finally ask him the obvious: "How will you deal with the Gazprom veto?"

The gas behemoth has a monopoly on exports. Nothing gets out of the country without its approval, and it does not like domestic competitors.

Bogdanov raises his eyes from the cup of tea in front of him and looks me square in the eye.

"We are in the process of solving that situation," he says, with that trademark sheepish grin.

I nod and change the subject. Both of us understand the message has been received.

The long trip from Moscow has been well worth it.

Hang On, Folks: The Russian Gas Sector Is About to Change
Gazprom is beginning to lose its grip; the Russian government is looking for other ways to balance the gas exports and maintain revenue; and a well-connected company like SNGS will be right in the middle of it. This is going to provide significant opportunities for both Russian and outside companies to benefit.

Capital investment is required, and a combination of Russian and foreign companies will be providing it. Moscow will need to make concessions on terms in order to generate interest.

There will be a number of great profit-making opportunities for investors coming... and what's more, you will not need to buy stock on the Russian trading systems to participate.

However, having achieved my trip objective, I find that my thoughts are now wandering ... I wonder whether there is any hot water left back at my hotel...

[Editor's Note: Dr. Kent Moors, a regular contributor to Money Morning, is the editor of "The Oil & Energy Investor," a newsletter for individual investors. In a career that spans 31 years, Dr. Moors has been consulting the energy industry's biggest players, including six of the world's Top 10 oil companies and the leading natural gas producers throughout Russia, the Caspian Basin, the Persian Gulf and North Africa.

As the preceding story demonstrates, Dr. Moors' experiences - as well as the unrivaled industry access, contacts and insights he possesses - are the backbone of The Energy Inner Circle, an energy-sector advisory service that enables investors to capitalize on his contacts and his global-energy-sector insights. For more information on that service, please click here.]

Source :

Money Morning/The Money Map Report

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