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Interview

with Alexander Djaparidze, CEO, Eurasia Drilling Company (EDC)

18.02.2010 / Energyboardroom

2009 wasn’t a great year for the Russian oil and gas industry as a whole. However, things now seem to be stabilising a little. How did the economic situation impact the services sector in Russia last year, and Eurasia Drilling specifically?

The main implication for the sector and for Eurasia Drilling was a reduction in the volume of jobs performed, and a small readjustment of pricing structures. Financially, companies working in Russia that report in US Dollars or Euros were affected by the devaluation of the rouble, which naturally impacted companies such as EDC, who are listed.

At the end of 2008 and the beginning of 2009, there were large concerns throughout the sector, but as the oil price stabilised and capital expenditure started to return amongst the big oil and gas players, it meant that 2009 was not as bad a year as had been anticipated.

I cannot say that Eurasia Drilling was completely ready for the crisis, but the company took reactive steps in order to reduce the impact of the decrease in sales volume. For example, the capital expenditure programme was scaled back; an overhead reduction strategy was put in place; we made some changes to the company’s personnel structure, and reduced expenditures on subcontractors. With these measures in place, despite the volume decrease and price restructuring, the company was able to finish they year with an increase in its financial indexes.

Eurasia Drilling recently signed a new framework agreement with Lukoil, which will take the partnership between the two companies up until 2012. Historically, you have made great partners: how will this new agreement affect the company as it develops over the next three years? Is your business too dependent on Lukoil?

This new framework agreement has provided the company with an excellent basis for future growth, and is mutually beneficial for both parties. EDC can utilise all its assets, which are currently located on Lukoil operations, and Lukoil can implement their drilling rig programmes under a known pricing structure and without paying new companies for mobilisation.

In 2010, Eurasia Drilling predicts that arrangements with Lukoil will account for approximately 60% of its business. When the company launched its IPO, analysts and investors expressed their concern about the risk of being a one-client company. At that time, the volume of the work that EDC was doing with Lukoil accounted for around 80% of its business. We promised that by 2010, this figure would be reduced to 60%, and so in that respect we have made good on our promise.

However, this is predominantly a concern of our shareholders, rather than the management team here at Eurasia Drilling. We know the advantages of having a reliable partner, and the value of any contract that comes from them.

It is important to remember that Lukoil is not the only reliable partner working in Russia today, and as a result a significant portion of the remaining 40% of Eurasia Drilling’s 2010 business will come from Rosneft and Gazprom Neft. In parallel to this, an important part of the company’s business development plan is to become one of TNK-BP’s service partners. In 2009, the company sold off their service business, and although EDC bid for it, it was eventually sold to Weatherford.

Did TNK-BP make the right decision in selling their service business to an international player like Weatherford?

TNK-BP definitely made the right decision in selling off their service company: by doing this, they received some revenues, and have taken an important step towards diversifying their supplier base. I was one of the few people supporting this idea as long as fifteen years ago, and today companies seem to have finally accepted the merits of this idea. In the end, it was the business logic of diversifying suppliers that convinced the oil and gas players that spinning off their service businesses was the right decision to make.

The first of the major companies to adopt this approach was Lukoil. In many regards, Lukoil has been the pioneer in the Russian oil and gas sector. They were the first vertically integrated Russian oil company, the first private company, and the first company to list on the public markets. Lukoil was influenced by the public market, and as a result made a lot of correct decisions, including spinning off their service business.

Since 2006, Eurasia Drilling has been involved in offshore operations, having established the company as the largest provider of onshore drilling services in Russia. Where are the company’s priorities today – consolidating this onshore position or developing this offshore potential?

It is unfortunate that right now in Russian waters, although many projects are being discussed, the only place where offshore activities are actually taking place is in the Caspian Sea, which is an area that does not belong exclusively to Russia. Eurasia Drilling believes that the Caspian offers great potential. There are currently only three jackup rigs and one semi-submersible being marketed in the Caspian offshore region. We know that the demand for jackup rigs in the next two to three years will increase, with demand justifying perhaps five more to be introduced. Semi-submersible rigs are mainly being used in Azeri waters by BP, and so I cannot speak to their demand, but in general, this is a very promising market.

Eurasia’s offshore business is proof of this concept. When we bought the offshore business from Lukoil, it included a single jack-up rig and accounted for about 3% of the company’s business. This year the figure will grow to between 7 and 8% and includes both our ASTRA jack-up rig and drilling operations on Lukoil’s Yu. Korchagin platform. With our current business in the Caspian, with one of the few jack-up rigs operating there plus the only platform in Russian waters, we have very ambitious plans. Eventually, this business will be expanded to other offshore areas in Russia.

How much of a challenge is getting the expertise to be successful offshore? With the larger of the planned offshore projects, Shtokman and Sakhalin, the government has invited international players to come and help, perhaps because in some ways they feel as if Russian companies lack the expertise necessary to make the projects a success. As a Russian company, what you Eurasia Drilling do to change these perceptions?

Being a Russian company is an equation of philosophy. My whole career in this industry has been dedicated to bringing Western technology and management styles together with Russian shareholders. This started in 1989 with MD SEIS, a Soviet-American joint venture. I followed the same model with PetroAlliance, a very successful company, and one of Russia’s largest oilfield service companies.

I don’t see any limits to this business model – finding the right technology in the West, and bringing it for implementation in markets such as Russia or China. It’s simply a matter of finding the expertise, and choosing the right team. For example, Eurasia Drilling has around twenty expats working in its Moscow office, experts in the business that we are engaged in.

With a philosophy like that, I suppose internationalisation of the company and its operations has to be somewhere on the agenda. Lukoil has just won a contract with Statoil for the West Qurna 2 oilfield; are you hoping you will be able to follow your partners to new countries like Iraq?

We are ready to operate in Iraq if invited. It’s difficult for a service company to operate in a geographical location where it has no historical expertise, but Iraq is a place where the Russians have a special level of expertise, due to the work the Soviets carried out there – we worked there perhaps more than anyone else. There are no secrets to operating in Iraq: you just need to bring the right equipment and organise the work in the right way.

I wouldn’t take Eurasia Drilling anywhere that we could not offer a specific advantage over other companies. However, to work with a client like Lukoil, with whom we have a very high level of trust and understanding, and to do so in a place where we can offer such an advantage would be a perfect opportunity.

How much of a challenge is it to distinguish Eurasia Drilling from its competition? Considering your company as an international player means competing with companies like Weatherford, Schlumberger and Nabors.

The biggest challenge comes from technology implementation. All those companies that you mentioned invest heavily in R&D. Eurasia Drilling is not yet in this position, although in our nearest plans the company will be investing in its own research and development projects to improve its own technology.

We have a long way to go, but the company has improved its efficiency levels incrementally over the last four years. In 2005, the drilling efficiency rate was at 70 metres per day, per crew. The figure for the first nine months of 2009 had improved to 110 metres per day. This is a key indicator of the company’s overall technical efficiency, but it also indicates to us that the company has a long way to go in order to compete with the high standards of international companies. However, at the same time, efficiency is always linked to the specific market and geographical operating location, so our figures are difficult to directly compare to those of other companies.

One way of gaining access to this technology is through acquisition of smaller companies with better technology. This is one of the ways that Eurasia Drilling has developed in the past. Is this something that will continue in the years to come?

For the time being, Eurasia Drilling needs to concentrate on improving efficiency. There is a lot of opportunity for both organic growth and mergers and acquisitions within Russia, and fortunately we know this marketplace better than anybody else. If the company finds an attractive potential asset that appeals to the strategic development of the company, then it will take this opportunity.

However, the company is not looking to make acquisitions simply for the sake of growth. For example, it was recently suggested that Eurasia Drilling might be interested in acquiring a small Canadian company, but after investigating this opportunity, it was clear that such a deal would not be very attractive. The company in question operated mainly in the Canadian market, which is in a state of decline, and has very small margins compared to the Russian market. We considered acquiring the company simply in order to take their 25 rigs and bring them to Russia, but after looking at the costs of moving the rigs and modifying them for the Russian environment, it became clear that this was not an opportunity the company should take. If we do indeed make any acquisitions outside Russian borders, they will be related to offshore drilling, and the technologies associated with this activity.

In terms of stock performance, 2009 wasn’t a great year for Eurasia Drilling. What would you tell portfolio investors, looking to Eurasia Drilling shares as a potential investment?

While it is true that our shares suffered in 2009 along with the rest of the market during the financial crisis, our stock price was up 385 percent by the end of the year from its price at the beginning of the year, so that overall our company’s stock performed extremely well. Nonetheless, we are not happy with our current share price as we currently trade below most of our peers in terms of EBITDA and earnings multiples. This provides an opportunity for portfolio investors to take a position now and benefit in the next few months as the broader market begins to correctly price in the fundamentals of our business, the talent of our management team and our growth prospects.

To the readers of Oil & Gas Financial Journal that watch your shares, what would you like to be your final message about Eurasia Drilling?

From my understanding, and from what Eurasia Drilling’s clients have told me, the company is the best oilfield service company in Russia. We are one of the biggest onshore drillers in the world. We are going to become the world’s major player in well construction: perhaps not the biggest, but definitely the best.

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