Dennis Francis , PetroNeft Resources PLC
Release Date: 2010-08-05
PetroNeft Resources plc is listed on the AIM market of the London Stock Exchange and is operating in Tomsk region in Western Siberia. The team of Russiaenergy.com met with PetroNeft CEO and former Marathon Oil executive, Dennis Francis, to talk about PetroNeft and his experience operating in Russia.With your years of experience at Marathon, it is safe to say that you are not new to the Russian industry. What has changed over the years, since you first arrived to do the Marathon deal at Sakhalin?
The system has changed dramatically here in Russia since the early 1990s. At that very delicate time, there was no stable system in place for taxation and fiscal policy, which made it a challenging country in which to have oil and gas operations. In order to encourage foreign investment, systems needed to be put in place, which would ensure a sustainable return on investment. Initially, this was done on projects like Sakhalin II, in which Marathon participated, through Production Sharing Agreements (PSAs).
Marathon, as Operator for the Sakhalin II Consortium which also included Mitsui and McDermott, won the Sakhalin II tender, which was a highly competitive tender for the right to conduct a feasibility study to develop two oil and gas fields offshore Sakhalin. This was completed using a combination of Marathon’s knowledge and Russian expertise. The team that was put together to complete this study included over fifty Russian experts working with Marathon in Houston, in addition to interpreters and translators, all working to ensure the quality of the study. The Russian team that worked with Marathon at that time came from Sakhalinmorneftegaz, which was eventually incorporated into Rosneft. As a result of the cooperation on Sakhalin, some very good relationships were made.
Once this feasibility study was completed, it meant that Marathon had the right to negotiate a Production Sharing Agreement. As this was the first such agreement ever negotiated in Russia, it took some time to complete, but the quality was excellent, as the Russians were very keen to get the formula right given the circumstances at the time. During this process Mitsubishi and Shell joined the project and Sakhalin Energy was formed, but Marathon remained as the Upstream Operator.
After the Agreement was negotiated, the next step was to lobby for the implementation of production sharing legislation in the State Duma, so that Sakhalin Energy could begin the project. This took a long time, nearly two years, but once it was done, Sakhalin Energy was able to finally put its first platform in place offshore Sakhalin.
Creating legislation in order for Western companies to implement projects under Production Sharing Agreements was a major change to the Russian industry. However, while the PSA legislation was being implemented other laws were put in place to stabilize the normal taxation and fiscal regime. These new laws and fiscal regime are now in place and form the basis for how most companies operate in Russia today – it took time to implement these laws at first, but perhaps as a result of these extensive efforts, it means that further changes will be minor and thoughtfully implemented. This gives some assurance that the business environment, especially for companies now operating in Russia is actually more stable and secure than in many other places around the world.
Although many speak of the opportunities for independent companies in Russia, compared to other oil-producing countries, there are actually very few juniors with operations in the country. What is the general situation for junior companies operating in Russia today, against a landscape dominated by the major Russian players?
The situation over the past year has been difficult for the junior companies primarily because of the uncertainties associated with the financial crisis. It was especially difficult for those companies with existing debt positions that needed to be renegotiated because of reduced cash flow associated with low oil prices in early 2009. Some of the companies have been consolidated by larger companies and some are still struggling to recover. PetroNeft has no debt and successfully raised $27.5 million through a share issue in September 2009 to International and Russian investors.
While most of the junior companies are developing small assets in the 5 to 50 million-barrel size range the Major Russian players have legacy assets with established infrastructure and production. They are largely concentrating on new fields and developments with over 500 million barrels in reserves so there is less competition for small projects from the Russian Majors than you might suspect.
What were the particular advantages of acquiring assets in Russia for PetroNeft Resources when the company was incorporated in 2005?
To begin with we had a knowledgeable management team that had worked in Russia for many years and had a proven track record of success. For the most part we were former Marathon Oil Company executives who had worked on Russian projects. I left Marathon Oil Company in 2003 after 31 years. Prior to leaving Marathon, from 1989 to 2003, I was responsible for Marathon’s Business Development activities in Russia including the progression of the Sakhalin II Project and formation of Sakhalin Energy. Our Chairman, Dave Golder, was seconded from Marathon into Sakhalin Energy as Senior Vice President Operations and was in charge of building the first platform offshore Sakhalin and the start of production. Our Vice President and General Counsel, Dave Sanders, was a lead negotiator on the first Production Sharing Agreement and many other Russian projects.
Even though Shell bought Marathon’s interest in the Sakhalin project in 2000, it was the basis of many of the personal business relationships and knowledge about working in Russia that has been advantageous to PetroNeft. Our General Director, Alexey Balyasnikov, was also a former Marathon employee who headed up Marathon’s representation office in Moscow and came to work for PetroNeft in 2005.
Since then Paul Dowling joined us as CFO in 2007 and, recently, Karl Johnson as Vice President of Business Development and Operations, both of whom had prior Russian experience and were well-known to the management team.
In Tomsk, PetroNeft can count many of the larger Russian oil players amongst its neighbours – Gazprom Neft, TNK-BP and Surgutneftegaz amongst others. What are the specific advantages of having PetroNeft’s operations concentrated to this particular region, over others in the Russian Federation?
One of our key advantages in Tomsk is our local management team. Our Executive Director, Alexander Frenovsky, was the General Director for Tomskneftegazgeologia and our Chief Geologist, Nikolay Karapuzov, was the Chief Geologist/Chief Geophysicist for Tomskneftegazgeologia. Tomskneftegazgeologia was the Soviet, and later Russian geological expedition, that discovered most of the fields in the Tomsk Oblast. Both of these individuals have worked successfully in the Tomsk Region over the last 30 years and have the knowledge base and relationships to facilitate our operation there.
I should also mention here that the Tomsk Oblast, headed up by Governor Kress, is recognized as one of the most business friendly regions in Russia.
What are the challenges of operating in a region where the company is competing for assets with such big players?
As I mentioned our business model targets the 5 to 50 million barrel type assets, which are below the radar of the major Russian Companies, so there is less direct competition for assets than you may suspect. In fact, many of the assets that we are looking at are being divested by the Russian Majors as they concentrate their resources on much larger projects. However, because of our size and business relationships in the region we are able to complete evaluations and move faster than most of our competition on assets we have an interest in. This was certainly the case in the recent auction for Ledovy Licence 67 that we won in December 2009.
How does PetroNeft stand as an example to other independent junior companies, showing it is possible to succeed and compete in Russia? What would you offer as key words of advice for achieving similar success?
Many of our peer companies have disappeared this past year via consolidation, poor management, or unforeseen problems brought on by the financial crisis. As a company we take pride in the experience and make-up of our board and management team and the strict corporate governance policies that we have put in place. Russia is not an easy country in which to operate. It has a large bureaucracy with its own set of rules and regulations. It takes a lot of hard work and perseverance, but we have proven that you can succeed if you have the right people and work ethic. We find that if you are perceived as a “well intentioned” company in terms of how you treat your people, comply with local and state regulations and meet your social obligations that you can be successful.
The key is really hiring the right people, talented Russians, that you can trust and then operating as a Russian company in the Russian system. Too many companies have failed because they have not employed the right people with local experience or have brought expensive western equipment that, for some reason, they think can do a much better job than standard Russian equipment when in most cases the only difference is that the western equipment is much more expensive.
In order to make themselves more attractive prospects for acquisition and investment, many smaller oil companies in Russia have slowed production and tried to increase reserves. How difficult has it been for PetroNeft to maintain a balance between production and increasing reserves, and where is the company more focused today?
Firstly, let me say that we are not yet in full year-round production, but are currently building the pipeline and field facilities in Licence 61 to start year-round pipeline production in the third quarter of this year. We expect to exit the year at around 4,000 bopd. This figure is expected to build to 12,000 bopd in 2012. Since acquiring Licence 61 we have drilled 6 wells, discovered two new fields for a total of four fields and increased our 2P reserves from around 30 to 70 million bbls. Today’s focus is to get the existing fields on year-round production in order to generate sufficient cash flow for further exploration. In Licence 61, we have identified over 25 additional prospects with potential P3 reserves over 450 million bbls that will eventually need to be evaluated.
While we are just starting with our detailed reprocessing of vintage seismic and well data on our newly acquired Licence 67 we are confident it also provides a good mix of proved development projects and upside exploration potential.
What would you point to as some of PetroNeft’s operational highlights from 2009, and what are your expectations for the company in 2010, what you have called in the press “a transformational year”?
To begin with, we put our Lineynoye development project on hold at the end of 2008 because of the worldwide financial crisis. Once it was delayed we immediately started to optimize the development by reducing the amount of cash required to get the project to the point where it could generate enough cash flow to be self funding. In August of 2009 we signed a transportation agreement with Imperial Energy that further reduced our capex requirements. As a result of these efforts and a favourable movement in the RUR/US Dollar exchange rate, our funding requirements went from $60 to $25 million. In September 2009 we raised $27.5 million in equity for the first phase of the Lineynoye project. Since then our Tomsk staff and local contractors have been working on the project implementation. The project is currently on schedule for year-round pipeline production in the third quarter of 2010. This will transform the company from an exploration company to an exploration and production company.
What are your expectations for PetroNeft’s drilling activity due to take place this year?
Our current plans are to drill 9 development wells from the initial pad in the Lineynoye field this year. The rig for these wells is currently being mobilized and assembled and we are scheduled to start development drilling in April.
How do you hope to influence the shape of the company in the years to come?
My goal, which is shared by the Board, is to build a successful growth oriented oil and gas company in Russia which is staffed primarily by Russian professionals but run under western corporate governance standards. Our intent is to operate in Russia as a Russian company utilising western technology only when there is a clear advantage for doing so. My primary influence here will be in the selection and training of younger employees and putting the proper processes in place to ensure the long term success of the company. We must maintain the strict discipline of the company with respect to operations and business development.
What lies in the future for PetroNeft, and for international junior companies operating in Russia in general?
PetroNeft is on course to begin year-round pipeline production in the third quarter of 2010. The commencement of production will mean the Company will generate significant surplus cash in the coming years to enable it to expand its reserve base in both Licence 61, Licence 67 and through business development opportunities in Tomsk and other regions. We have worked hard to get to where we are and we are optimistic about our future.
The Russian tax regime is stable but it is onerous and there are areas where small changes would significantly help junior companies who are implementing new projects for small fields. For example, proposed legislation that would give MET tax relief to small producers would certainly improve the situation for the junior companies.
Final Message from Mr. Francis to the readers of Oil & Gas Financial Journal: colleagues, investors and competitors from across the globe, about PetroNeft Resources.
PetroNeft has an outstanding asset base with a mix of production and exploration projects. It has set high technical standards for the systematic exploration, planning for production and compliance with government requirements. The company has also developed a good working relationship with the financial markets in order to fund these developments. These solid foundations provide an outstanding platform for PetroNeft’s development and growth.
| Company: | PetroNeft Resources PLC |
| Position: | Chief Executive Officer and Executive Director |
| Country: | Russian Federation |