Gazprom Neft CEO Alexander Dyukov talks to RBC about how the company’s relations with international partners are developing, whether politics has any impact on the company’s work, and whether it’s worth waiting for further consolidation in Russia’s oil industry.
Russia’s second-biggest state-owned oil company (by production volumes), Gazprom Neft has a modest approach to mergers and acquisitions. Not that this has impeded its growth. The past 10 years have seen the company’s production and refining volumes increase two-and-a-half-fold, to 86 million tonnes of oil equivalent (mtoe) and 42 million tonnes of oil products. Interviewed by RBC, Gazprom Neft Management Board Chairman Alexander Dyukov explains why the company has never sought aggressive buyouts of competitors, what assets it’s interested in abroad, and why it’s currently more profitable operating in Russia. Dyukov, who has already been heading-up Gazprom Neft for 10 years, also explains why he’s never considered running his own business.
You’ve got to be proactive
— In May OPEC, as well as other countries not part of the cartel, agreed to continue their agreement on limiting production until March 2018. Many see risks in connection with this deal: shale production in the USA is growing, and there is a risk that oil prices will fall again. You have talked about how the regulator now needs to be very flexible in reacting to any change in the market. In what way?
— I think, now, the regulator needs to have two goals. Firstly, to genuinely balance supply and demand, to take surplus stocks out of the market. And what’s important here is not just achieving that state of balance, but also maintain it, in the future.
The second task — which, it seems to me, is underestimated, but which in fact it is very important —concerns managing market expectations regarding the oil price. I mean, managing the forward curve — it’s important it remains flat. The situation of contango (where the market is relying on an increase in the oil price) can be dangerous, since it could encourage investment by shale oil producers. Anticipating high prices will also help them in hedging against future production, which could, again, lead to increasing shale production destabilising the market and, consequently, lead to further high volatility and a drop in oil prices. To solve both the first and second tasks, you’ve got to be proactive, you need to monitor the situation and react quickly to what is happening in the market.
— Vygon Consulting estimated recently that, while the OPEC deal is helpful to the Russian budget, Russian oil companies could miss out to the tune of RUB70 billion in 2017. Do you agree with this assessment? And is some form of compensation for the oil companies possible?
— I have to say, straight away, that we won’t be considering the question of compensation. I’m not familiar with Vygon Consulting’s calculations, but in order to work them out you’d need to know what the oil price and the exchange rate against the dollar would be had there been no agreement with OPEC — and there is no longer a direct correlation between the oil price and the ruble exchange rate. It’s obvious that a higher oil price is a positive factor for oil companies. On the other hand, oil companies, of course, are negatively impacted by a stronger ruble. Gazprom Neft, as you know, has, in recent years, aggressively expanded production — by seven to nine percent per year — and, of course, we had planned to continue growing at that same rapid pace. Following the OPEC agreement, instead of growing at eight to nine percent, we have increased production by just 4.5 to five percent. Which is, without a doubt, a negative factor for us.
But, in general, I think continuing the agreement to cut production is the right move, and will remove unnecessary volatility and unpredictability. The agreement will benefit both consumers and producers and — and this might sound a bit pompous — the global economy. In addition to which, we fully understand that, in a low-oil-price environment, the Russian oil industry needs to be prepared for sudden and unexpected interventions, directed at increasing the burden on the industry, from the Ministry of Finance.
— Following the OPEC deal Russia gained two major international partners — Saudi Arabia and Qatar. You’re already discussing technological partnership with Saudi Aramco. If we’re talking about the long term, how interested are you in this company as a partner?
— Let’s not get ahead of ourselves, we only just getting to know one another. Gazprom Neft executives visited Saudi Aramco production facilities for the first time a few months ago, we’ve had a look at their production assets, their R&D and engineering centres, and have seen how training is organised.
During the St Petersburg International Economic Forum we showed Saudi Arabia’s Minister for Energy, Industry and Natural Resources [HE Khalid A. al-Falih] round our Science and Technology Centre. It turns out that our Technology Strategy, in large part, corresponds to the technological challenges facing Saudi Aramco. Obviously, in certain places objectives don’t align, but we may well find areas of common ground. We haven’t yet discussed any joint projects in exploration and production. It’s possible, but that’s a matter for the future.
— The Russian Direct Investment Fund (RDIF) is investigating projects of $12 billion with the Qatar Investment Authority (QIA). Are you interested in working with the Qatari fund, and are there any projects you could offer them?
— Neither we, nor the Qatari fund, have taken the initiative, we haven’t had any contact thus far. We are working with a range of other funds through the RDIF, with whom we’re discussing various projects.
— According to your strategy to 2025 you are planning to produce only 10 percent of your oil abroad? Why so little?
— An international presence upstream is a strategic objective for us. There are certain regions of major importance to us, above all in the Middle East. But as regards any specific percentage — 10 or 15 percent — it’s not that important, in context. We will be guided by economic expediency. If it makes economic sense for our project portfolio to include five percent of production abroad, then we’ll have five percent. If it’s going to be profitable to have 15 percent, then we’ll have 15 percent.
— Are projects more profitable in Russia than abroad, at the moment?
— Yes, at the moment, following the collapse in the oil price, that’s completely obvious. Russia’s oil industry is helped by the devaluation of the rouble and the tax system [RBC: the state receives most of the price in taxes, so any fall in the oil price means the state loses out]. Our production is more than competitive in comparison with other reserves under development worldwide. Of course, it’s possible our production is slightly less competitive than production in the Middle East, but, overall, production in Russia is fully competitive.
— Are you mainly interested in upstream projects abroad, or are you also interested in other areas — petrochemicals, oil refining?
— Naturally, we’re not just developing upstream. To be honest, the main focus in refining at the moment is on modernising our refining plants in Russia: we want to make our refineries the most efficient — we want them to produce as many light and other petroleum products as possible, at the greatest added value. But we are also working out options for buying oil refining and petrochemical assets abroad. In order for these deals to happen though, two conditions have to be met. First, the purchase of any asset must allow us to protect our market share in the oil market — that’s a strategic rationale. The second very important requirement is economic feasibility, and here the situation is complicated. There are now practically no acquisition target assets at which it would be possible to make a guaranteed return on investment. We, nonetheless, are studying several assets, but whether there will be any deals, it’s too early to say.
— Following the lifting of sanctions, international companies rushed into Iran. Gazprom Neft is currently considering two projects there — Changuleh and Cheshmeh-Khosh. But there is a view that the internal rate of return (IRR) on Iranian projects is too low.
— It is, at the moment, too early to assess the rate of return. First, we have yet to get acquainted with the details of the new Iranian contract. We have practically completed project feasibility studies and plan to start individual consultations on our blocks with the Iranian side, in the near future. After which we’ll be able to understand the likely yield on the investments we need to make on these projects.
— You recently reached an agreement with Austria’s OMV on working together in Iran. Are we talking about just these two blocks, or maybe broader cooperation?
— We have known OMV for a long time: as you know, they’re working with our parent company, Gazprom, and have proved themselves to be a reliable partner. OMV have already got several blocks in Iran, and we see certain synergies in our partnership, both in terms of infrastructure and in terms of management. We’ve had some initial consultations with the Iranian government and the Ministry of Petroleum, and they take a positive view of such a potential alliance.
— You wanted to acquire new blocks in Iraq. What blocks would these be, and how do you intend to develop this region, generally?
— Iraq is a very important region to us, we know it very well, and we have been successfully developing the Badra project, one of the most geologically complex fields in the country. You know we had a visit from Iraq’s Minister of Oil [Jabbar Ali Hussein Al-Luaibi ], and he offered us some new projects to look at. That’s interesting to us, in principle, since we know the region well. So we’re waiting for some more concrete proposals from the Iraqi side.
“We’re obviously growing. But how you grow — that’s already a secondary issue.”
— Gazprom Neft is Russia’s second biggest oil company, with serious lobbying resources. Nonetheless, you have a pretty conservative policy as regards mergers and acquisitions. Why?
— You know, our shareholder [RBC — Gazprom] sets us three tasks. The first is to grow the scale of the business. Secondly, we have to grow efficiently. And third — we have to maintain our financial viability. As you see, Gazprom Neft’s size, and the geographic range of its activities, have changed considerably over the last 10 years. Production volumes have increased two-fold, refining volumes by a factor of 2.5. The fastest growth in recent years has been in production in Russia [RBC — about seven percent against an industry average of approximately two percent in Russia over the last two years]. Our product-sales network is growing, as is our premium-sales network; and, moreover, we’re doing all of this effectively. If you look at our performance in terms of economic efficiency, we’re one of the market leaders. Added to which, we’re maintaining our financial viability. We’re obviously growing. But how you grow — whether through mergers and acquisitions or organically — that’s already a secondary issue.
— At the St Petersburg International Economic Forum recently you had — in his absence — words for former Finance Minister Alexei Kudrin, who had suggested privatising all oil companies for a period of seven to eight years. You said that state-owned companies are often more effective than private ones. How do you explain that?
— Aleksei Leonidovich [Kudrin] voiced a certain hypothesis, but let’s turn to the facts. I suggest he compare our company with other private companies; and if he can genuinely prove to me that private companies are more effective, I’m ready to admit it. By the way, continuing what Alexey Leonidovich said, the head of Shell, Ben van Buerden, said that, in principle, he agrees with Mr Kudrin. But I’d like to answer that, gain, as follows. You know that we have a joint asset with Shell — this being the Salym group of fields, which we take turns to manage. And you know — in comparing the quality of management there, I wouldn’t say we’re in any way inferior to Shell.
— And what do you think about the consolidation of the oil industry in Russia — do you think that’s the right move? Or the more players the better?
— This is a global trend, and if we look at what’s been happening over the last 30 years you see a whole wave of very serious mergers not just in Russia but in the oil industry worldwide. You’ll be familiar with examples of these — Exxon, Mobil and so on.
— Do you expect consolidation to continue in Russia, or has it already run its course?
— It’s difficult for me to talk about what’s going to happen. If there’s an economic case for consolidation, then it’s quite possible we can expect this trend to continue.
— The oil industry is major-league politics, especially where it concerns state-owned companies. Are you, in taking decisions on new investments or expansion abroad, often driven by political motives?
— We’re driven, above all, by economics. In particular, the Gazprom Neft Board of Directors, in taking decisions, is driven by economic expediency, and the strategic importance of one decision or another.
We’re doing alright without Western partners
— Tell us how Gazprom Neft will be developing in one key region, Yamal. How much do you plan to invest, in the long term? Will you be acquiring new licences or will you be focussing on existing blocks?
— Yamal is certainly a strategic region for us: Gazprom Neft — and, before this, Sibneft, has had a presence there historically. In the long term we plan to invest hundreds of billions of rubles into this region.
— Last year, we commissioned two very large fields — the Novoportovskoye field and the Messoyakhskaya group of fields (the Vostochno-Messoyakhskoye field). These hold huge reserves and production volumes are, already, significant. We, of course, will continue to bring these under control: we are currently building new wells, and expanding technological infrastructure. In addition to this we will, in the nearest future, start developing several new fields — the Severo-Samburgskoye and Tazovskoye fields. And, concurrently with this, infrastructure is already being put in place in this region which will allow us to begin developing neighbouring fields, including both distributed reserves and open acreage, although this is all something for the future.
— You have a number of agreements in place with foreign partners on developing the Arctic Shelf, but none of these, as yet, have culminated in a deal. Why — are you just not in a hurry, or are foreign partners approaching projects with caution, because of sanctions?
— There has been some progress in this process, although we aren’t, perhaps, moving at the speed we might like. But the problem here is definitely not sanctions. The main reason is, obviously, the low oil price. Investors are currently reluctant to enter into complex projects — such as offshore deepwater development, work with high-viscosity oil, or with bituminous shales — and projects on the Arctic Shelf can certainly be counted amongst these. But negotiations are ongoing, all the same, and we see a positive trend here. In any event, we will continue implementing our geological prospecting programme, with international partners, or without them.
— Gazprom Neft plans to be producing 2.5 million tonnes of oil at the Bazhenov Formation by 2025. How much is production technology likely to cost? How do you plan to develop these blocks — independently or with Western partners? Could the state provide support?
—We can’t involve Western partners because of sanctions, and I think we’re doing alright without them. Their presence, perhaps, wouldn’t hurt and, in some instances, might even help, but it’s not critical to us.
It is hard for me to assess the investments needed for commercial exploitation and production at the Bazhenov Formation. I can cite our estimates of the investments we plan to make on our Palyanovsky block. This block has been awarded the status of a national project, and we are testing various technologies there that will allow us to work effectively at the Bazhenov Formation. According to our estimates, we’ll have invested about RUB8.5 billion in this block by 2020, of which RUB7.5 billion will be met by Gazprom Neft (and the rest — by government financing through the Ministry of Industry and Trade).
What would we like to receive from the state? We’re waiting for the government to make it easier for other companies to work at this block. We see this block as a kind of technological testing ground, a platform from which other participants can also test their technologies. We would like to see engineering and oilfield service companies working there, as well as machine building companies and companies working with digital technologies. And what Gazprom Neft needs most immediately is a special license that would allow work to be undertaken in pilot-development mode.
— Gazprom Neft shareholders approved a record dividend in 2016, of RUB50.6 billion. What’s your forecast for 2017 — can we expect a new record?
— We expect 2017 to be just as successful for our company, and hope the positive trend in net-profit growth — and, accordingly, dividends — will continue. Of course, it is too early to make any forecasts. To do this, you’d need to understand what the average oil price rate will be over the course of the year, and what the exchange rate will be. Nobody’s going to answer this question, most likely. But, what I can say, with some confidence, is that we will increase production this year, we will increase the production of light — that is, high-margin — oil products, and we will continue developing our premium sales channels, allowing products to reach end-consumers with maximum added value.
— Oil-industry workers have long been awaiting the introduction of the brand new “additional income tax”. Are further changes to the tax regime necessary, in your view, and, in particular, with regard to refining? For example, the Ministry of Energy recently announced that the government could grant a deferment in respect of excise duties for refineries undergoing modernisation.
— What does Russia’s oil industry need? Two things. The first of these being stability in the tax regime for oil refining. Following the “big tax manoeuvre” the tax burden on our oil refining operations increased substantially, and the average margin at our refineries is now worse than that at European plants, even though refining in Europe has always been notorious for its low profitability. So, in terms of oil refining, you need to at least maintain the existing regime, not make it more stringent. If we’re talking about production then, of course, the “additional income tax”, which has, already, been under discussion for some time, would be a universal solution and would make our subsoil use more sustainable, as well as increasing both budgetary revenues and the effectiveness of oil companies’ investments. There has been progress on this issue — the bill is ready and is now being considered by the government. We expect the State Duma to take the appropriate decision this year. And this will be a very important event for the Russian oil industry.
— December last year marked your tenth year at the head of Gazprom Neft. Could you sum up what have been the most important outcomes, for you personally?
— For me what’s important is that the company has been through a serious transformation. Gazprom Neft didn’t just change in terms of its size and the geographic range of its activities, but became something altogether different. Even in the face of worsening reserves and a lower oil price, we’re expanding the business and continue to develop. Today we are working with hard-to-recover reserves, which Russian companies didn’t know how to approach, even 10 years ago. During that time we have demonstrated that we can compete on the same level with international companies. Our team is implementing major, ambitious projects. We are treated as equals, and this, without a doubt, is a very significant achievement.
— Company leaders do sometimes go off to launch their own private businesses — you’ve never thought of doing this? Do you like being a hired hand?
—You know, I love what I do, and I’ve never thought about going into private enterprise. Theoretically, probably, anything is possible. What’s important for me is the scale of activity and, accordingly, the extent of the changes that I can initiate and bring to fruition.
Author: Alina Fadeeva