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Interview

with Marina Sedykh, CEO, Irkutsk Oil Company

08.07.2013 / Energyboardroom

To begin with it is very interesting to come across an exploration and production company whose roots are in Eastern Siberia, a region not traditionally associated with exploration and production and one that is – or at least was – fundamentally lacking in infrastructure. What were the reasons therefore behind creating this company in this region in the year 2000?

To answer your question, I will need to give a little background of not only the history behind Irkutsk Oil Company’s creation but also the general situation for oil exploration and production in the Irkutsk region. Studies of oil and gas potential in the region began in the late 1930s. However the available oil reserves were not confirmed until 20 years later, since the exact data for the available reserves did not meet the necessary industrial requirements for exploration at that time. A more detailed mapping was carried out in 1952, but the results were only confirmed by drilling data acquired by VostSibNeftegazGeologiya (an Eastern Siberian geological company) almost 10 years later. In 1960, VostSibNeftegazGeologiya drilled the first exploratory well near Ust’-Kut, which brought about its first important discovery; by 1963, this well was producing around 1000 cubic meters per day.

In the early 1990s, VostSibNeftegazGeologiya stopped its operations as state orders and financing was brought to an end. In 1995, Bodaybo Energy Company (mainly owned by Buynov family) and VostSibNeftegazGeologiya created NK Danilovo that took the joint license for exploration and production at Danilovo oil and gas condensate field. In 1996, the licenses for Yarakta and Markovo oil and gas condensate fields were given to UstKutNeftegaz, created jointly with the administration of Ust’-Kut region. The enterprise was too much of a burden for the regional administration as there were almost no tax revenues and salaries were thus not being paid. By 1999, UstKutNeftegaz was on the verge of bankruptcy. In 2000, the owners of Bodaybo Energy Company, with my involvement, created Irkutsk Oil Company (INK), which bought out Ustkutneftegaz and NK Danilovo. It took us six months to clear the debts and by the end of 2000 INK started operation on three fields in the Irkutsk region. Indeed, the conditions were far from good but it was also very exciting to be the first company to develop oil and gas production in the region. Moreover, this was officially recognized: for three consecutive years, from 2006 to 2008, Irkutsk Oil Company featured in the Irkutsk region’s Book of Records as ‘the first company to start commercial oil production in the region’ (2006); as ‘the largest oil producer’ (2007); and as ‘the first company to produce 1 million tones of oil’ (2008).

How do you explain the fact that since its inception INK has been the leader in oil and gas production in the Irkutsk region and how does INK maintain this position?

As soon as the company was established in 2000, we were challenged by the absence of the existing infrastructure. Still we wanted to become the first company in the region to start commercial production of hydrocarbons. So, our job was to take on a qualified workforce, determine and apply new field development technologies, build the entire infrastructure (roads, electricity lines, pipelines) and – most importantly – ensure year-round oil delivery to the oil terminal in Ust’-Kut. We managed to accomplish all of these goals. The first pipeline to connect the fields of Yarakta and Markovo was constructed in 2002; the rest of the track, Markovo – Ust’-Kut, was covered by a year-round motorway to the oil terminal where oil would be shipped by rail to the refineries of Siberia and the Far East. This pipeline uses unique military technology that had never before been applied in under such extreme low temperatures. In 2007 the last part of the pipeline was finished, from Markovo to Ust’-Kut, closing the cycle of oil transportation from both Yarakta and Markovo. Currently part of production is exported to Asia-Pacific via the Far Eastern seaport.

In spite of all the complications, INK has become an efficient company in terms of its ROI and its regional scale, with a workforce of about 1000 people and a solid position in the market. Today INK pays over 500 million rubles (over 17 million USD) in taxes annually.

It was obvious that the only way for the company to ensure its future development was to increase its reserves, and so we were participating on a very active basis in all kinds of tenders for exploration and production of hydrocarbons in Irkutsk region. As a result, we have purchased seven licensed sites, one gas field and discovered 2 gas fields and one oil and gas condensate field.

To keep this successful development, INK has continued to improve field infrastructure and increased the intensity of well drilling. As a result, in 2009 we managed to double oil production and deliver commercial oil as the end product compliant with the state standards. As the pumping capacity of the current pipeline is limited to 700,000 tones of oil per year, whereas our planned production rate is 3.5 million tones of oil per year, it was decided to connect INK’s major fields– with East Siberia-Pacific Ocean (ESPO) pipeline near the Markovo field. The length of this new connecting pipeline will be 64 km, which INK plans to commission in January 2011.

Finally, another accomplishment is in the field of gas utilization (including associated gas). INK has constructed and will shortly launch the first stage of the re–injection facility at the Yarakta field. Aside from the similar Vankor situation, this is a unique project for Russia. To explain the technicalities simply after gas preparation and separation, methane will be pumped back in to maintain the reservoir pressure and increase the recovery ratio of oil and gas condensate. This project will further allow us extinguish all the flares at Yarakta field. In this respect, INK is involved in the project of the sales of CO2 reduction units.

Obviously, such infrastructure projects require immense investment, which INK has managed to obtain through bank loans and its own cash flow. The loan issued in 2002 by the Irkutsk branch of the Savings Bank of Russia, our first lender among the banking institutions, was used to construct the first stage of Yarakta-Markovo pipeline. Some of our other banking partners are VTB, NOMOS-Bank, Raiffeisen Bank and EBRD.

It’s very interesting to hear how important it was for the company to attract the investments from banks. In 2008 you got financing from the European Bank of Reconstruction and Development (EBRD). Was this enough to go on, or are further investments being planned in order to increase the transport capacity?

EBRD became one of INK’s shareholders with an 8.15% share in 2008. The proceeds from this sale were used to refinance some lines of credit and invest in development projects. Later on, in 2009, despite the world’s economic crisis EBRD provided us a loan of €90 million so that we could continue investing in field development and construction of infrastructure. The bank also provided us with a social and environmental development plan which we follow in order to comply with their strict requirements in ecological, industrial and labor safety, as well as for the social development of the territories where INK operates. Environ, our environmental consultant, regularly checks our compliance. They work jointly with the corresponding department of EBRD. We’re also making a lot of environmental and social investments: we invested around 120 million rubles in 2008-2009 alone.

How did your partnership with Japanese Oil, Gas and Metals National Corporation (JOGMEC) start in April 2008 and do you see INK potentially associating more closely to the Eastern Asian market especially in the context of the construction of the ESPO pipeline?

In October 2007, INK and JOGMEC created a joint venture , INK-Sever (INK-North) for development of Severo-Mogdinsky licensed block in one of the remote northern parts of the Irkutsk region. In 2009, INK and JOGMEC created a second joint venture INK-Zapad (INK-West) for the discovery, appraisal and exploration of hydrocarbons on the West-Yarakta and Bolshetirsky licensed block. INK owns 51% and JOGMEC 49% of shares in each of the companies. I would like to note that this cooperation was approved bilaterally by the former Prime Minister of Japan and Vladimir Putin, the then-President of Russia.

To date, INK-Sever has invested about 1.4 billion rubles in the development of Severo-Mogdinsky field where drilling of the first exploratory well has just been finished with very promising results.

As for construction of the connecting pipeline to ESPO, INK intends to sell all of the oil to the Asia-Pacific region – indeed, this is precisely what ESPO was built for. Besides, we hope to shortly see the Russian Government approving the reduction of export duties for East Siberia.

Can this be considered a gateway for international oil companies into the Russian market?

Japan is looking to diversify its oil supplies. Today it mainly imports oil from the Middle East but in future Japan will also be looking towards East Siberia’s oilfields. It is possible that some portion of Russian oil exports would go to Japan. Moreover, working together closely with Japan is not only an apposite partnership financially-speaking, but also a good opportunity for technology transfer because the Japanese companies and their foreign partners are promoting new technologies across all areas of our work. The President of JOGMEC, Mr. Kavano, has announced that such joint ventures “enhance the relations of Russia and Japan and promote new joint ventures, as Japan is focused on cooperation with Russia”.

Why would you say INK became the partner of choice for the Eastern companies? What attracts them to the company and the Irkutsk region given that there are other Russian regions that are even closer to Japan?

Japan also collaborates with Sakhalin in the area of oil production. In the case of INK, the interests of the Japanese companies in Russia happened to coincide with what we were looking for in a foreign partner. INK understood that its exploration and production activity in the region required huge investments. We also wanted to share the exploration risks because we only had three operating fields (out of 11) and seven licensed blocks. Moreover, banks are very reluctant to finance exploration activities. So, INK was looking for a partner in exploration and JOGMEG was looking for a partner to diversify its sources of oil delivery.

Some independent mid-sized players in Russia often criticize the tax system that allegedly benefits big players. What is your assessment? Is the current tax system not beneficial for independent players such as INK?

As far as I know, the Russian tax system is fair to both the state and private companies. As for INK and the oil and gas companies in East Siberia in general, we don’t feel mistreated because the government’s priority in case of ESPO was to fill it with oil, and indeed today it doesn’t transport much East Siberian oil. This is why the state introduced temporary ‘tax holidays’ where the oil production tax in East Siberia was temporarily levied. The tax holiday system is intended to stimulate further field discoveries and eventually deliver more oil into ESPO pipeline as it frees cash-flow available for investments.

Besides, the Russian Government is currently looking into the issue of introducing a discount for export-duties for oil produced in East Siberia and delivered to the ESPO, which would allow us to invest even more in exploration and development of fields and further increase oil production in Irkutsk region. It could be said that East Siberia is to be the next huge oil and gas province of Russia!

I would also like to touch the issue of gas production tax. Using recycling processes with the current tax system forces us to pay the tax for gas production more than once. A few oil and gas production companies have applied for abolishing the gas production tax because, obviously, it’s ridiculous to pay for the gas re-injected back into the formation. This initiative was supported by the core authorities and we hope to see the corresponding changes in the Tax Code in the near future.

What are your main ambitions and expectations for the next 5 years and your final message to the readers of Oil and Gas Financial Journal in Russia and internationally?

INK is proud to be a pioneer in the development of Russia’s second largest oil-bearing province. One of our core principles is to work safely and responsibly for the future generations. Hopefully, we’ll manage to increase not only our production but also the reserves. INK is encouraging other oil companies to invest in East Siberia. If you look back, even five years ago, nobody was seriously considering East Siberia as an oil and gas province. Just consider what has happened since then: construction of ESPO, one of the largest transportation systems in the world, discoveries of giant fields of Vankor, Talakan, VerkhneChona – to name but a few.

Believe me, we will discover several more fields – in the past three years alone INK has discovered and contoured three new fields – and, given a favorable tax regime, East Siberia offers great opportunities.

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