Monday, June 9, 2008

Gazprom’s Oil Subsidiary “Gazprom Neft” Aims to Become Russia’s Leading Oil Producer

Gazprom Neft (ADR: GZPFY), the oil production subsidiary of Gazprom has stated in its 2007 Annual Report that it expects to more than double oil output to 2.0 million barrels per day by 2020 from a production average of 864,000 bpd in 2007. A production figure of 2.0 million bpd would be higher than all other Russian oil producers, if they do not achieve significant production growth going forward. Lukoil’s production in 2006 was 1.92 million bpd and Rosneft’s annual production average in 2006 was 1.6M barrels per day. Gazprom Neft's production target is assessed to be attainable, mainly due to the Company's ownership of the massive, and largely undeveloped South Priobskoye oil field, one of Russia's largest known oil fields, known in Russia as "the Pearl of West Siberia." Additionally, Gazprom Neft has also indicated that Gazprom will transfer its oil fields -- containing an estimated 5 billion barrels of possible oil reserves -- to Gazprom Neft. Further, Gazprom Neft has signed a 51%/49% joint venture with Lukoil in early 2008 to develop and produce undeveloped oil fields. Lastly, it is possible that Gazprom Neft will continue to consolidate large to medium sized producers of oil -- Gazprom Neft acquired 50% of mid-sized Slavneft (420,000 bpd) and 50% of Tomskneft (260,000 bpd production) within the last 12 months.

The factors suggest that Gazprom Neft's oil production and reserves have a high probability of more than doubling by 2020, and the stock price, at a current market capitalization of $38Bn (at early 6/08), should increase over the intermediate to long term.

Gazprom Neft Overview:

Gazprom Neft is the gas giant Gazprom's oil production subsidiary, with production of 864,000 bpd and proven reserves of approximately 4.5 billion barrels of oil equivalent in 2007. Most of Gazprom Neft's current assets are represented by the predecessor oil firm Sibneft, which Gazprom acquired in 2005 for approximately $US13Bn. The name of "Gazprom Neft" is interesting in that the name "Gazprom" means "Gas Company" (Gaz = gas and Prom = industrial company) in the Russian language-- Gazprom was organized by the Russian government in 1991 to hold the vast majority of Russia's gas producing fields and transport infrastructure. Gazprom added the name "Neft" to its oil production subsidiary in 2005 -- "Neft" in Russian translates to "Oil," and as such "Gazprom Neft's" name is illustrative of the Russian government's move towards currently -- it will be argued in this article -- consolidating the Russian oil industry in addition to the previous, successful moves which consolidated the Russian natural gas industry.

It should be noted that Russian oil production is very large, as the IEA reported on June 11, 2008 that Russia has passed Saudi Arabia as the world's #1 oil producer, with production of 9.5M bpd verses Saudi Arabian production of 9.2M bpd. As such, Gazprom Neft, with current production of under 1 million barrels per day of oil production, has significant room for production increases if it serves as the Russian's government vehicle of the consolidation of the oil industry.

Gazprom Neft's Planned Development of South Priobskoye, "The Pearl of Western Siberia:"

The Priobskoye oil field is a relatively new oil field in Russia, with oil production only starting up on a large scale in 2001 in the Northern portion of the field. Production for the field is ramping up rapidly on a large scale. Gazprom Neft produced approximately 125,000 barrels per day of oil from Priobskoye in 2007, and announced in mid 2007 that it plans to increase production by 2.6 times to over 300,000 bpd in 2010. ("Russian Gazpromneft-Khantos Oil Output To Rise 2.6-Fold by 2010, Energy and Commodities Digest, 8/21/07). Gazprom Neft also announced a development budget of $US11.22Bn for the next three years for all undeveloped fields, with a large chunk to South Priobskoye.

It should be note that the entire Priobskoye field is divided into two segments, North Priobskoye, which is owned and being developed by Rosneft, and South Priobskoye, which is being developed by Gazprom Neft. Rosneft's portion of Priobskoye is listed as its largest field by a factor of 4 in terms of reserves in its latest annual report, and is also Rosneft's largest producing field. Rosneft produced approximately 550,000 bpd of oil from its northern portion of the field in 2007, while Gazprom Neft produced approximately 125,000 bpd from its Southern portion in 2007. The northern region of Priobskoye is larger, although Gazprom Neft's area is not a "quarter" (ie, 25%) of the field as has been reported in some publications -- Gazprom Neft's area of the field is approximately 40% (see this map at JPT Online for a visual split of ownership area between Gazprom Neft and Rosneft at the Priobskoye oil field -- Gazprom Neft's ownership is Sibneft's former ownership and shaded in green). Gazprom Neft has not devoted significant resources to the development of South Priobskoye -- at least in terms of capital expenditures -- as of early 2008, although plans to devote the majority of future development expenses to this field from 2008 onward.

Can production increase further beyond 2010 at Priobskoye? The entire Priobskoye oil field is very large, measuring 5466 square kilometers as a whole in size compared to Ghawar (world's largest oil field, located in Saudi Arabia), which totals approximately 7,500 square kilometers in size. It should be noted that Ghawar is known within the petroleum geology as the "King of Kings" of oil fields, and any oil field coming close to Ghawar's size in terms of geographical area shows high promise. Priobskoye's size has wowed even the respected consulting firm Schlumberger, as shown in on page 3 of this Hart's E&P issue, in which refers to Priobskoye as so large that it is "startling." Oil reservoirs are in reality volumes of rocks with varying volumes of oil -- at this point the author has not seen information concerning the technical details of Priobskoye concerning porosity (volume of area that is filled with oil verses rock), permeability (ability of the oil to flow) - however from a first impression the field appears very large and capable of sustaining oil production volumes of well over 1 million barrels per day.

Note that for reservoir characterization purposes, not only the porosity and permeability but also the reservoir thickness levels would preferably be known, to determine the economics of production of the oil field. Rosneft has stated that its region of Priobskoye has low reservoir thickness as stated on page 136 of its IPO prospectus, which can be found here (large pdf warning). The low reservoir thickness makes horizontal drilling "virtually impossible" according to Rosneft -- but initial flow rates are kept high by immediate fracturing. Translation - the field will require some capital expenditures to ensure high oil flow and development, but due to the massive area of the field, the overall reserves and production with advanced levels of development are likely high.

Chart 1 shows the relative size of Priobskoye compared to the metropolitan area of Houston, Texas, for a unique perspective on the size of the oil field.

Chart 1: Priobskoye Oil Field Size Comparison:

Source: Hunt's E&P

A geological assessment of the total oil potential of Priobskoye was completed in 2004 by the former Russian oil company Yukos (the now bankrupt Yukos owned the development rights to Priobskoye in 2004), and audited by the petroleum geological firm DeGolyer & MacNaughton, which can be found here. The study indicated 27.6 Billion barrels of recoverable oil at Priobskoye -- it is ambiguous, however, if the study refers to all of Priobskoye or the Northern portion of the field. In the case that the number refers to the total field, the number of 27.6 Billion recoverable barrels would place Priobskoye as one of the 10 largest oil fields in the world. In fact, 27.6 Billion barrels of recoverable oil would place Priobskoye as a larger oil field than Samotlor -- the largest producing oil field in Russia to date, with 20 billion barrels of recoverable oil. Note that Samotlor produced a peak of 3 million barrels per day of oil in the early 1980's, and, based on resource size, it is possible that Priobskoye could produce a similar number at its production peak, which would imply an increase of 2.3M barrels per day for the total field from a current production figure of 675,000 bpd.

In summary, it can be assessed that South Priobskoye will likely achieve its planned 2010 production rate of 330,000 bpd by 2010, and likely has the geological resources to achieve 1 million barrels per day of production by 2020 -- which would imply that all of Gazprom Neft's 2020 production target of 1.8 Mbpd of oil production would come solely from increased production at Priobskoye. But it should be noted that in addition to Priobskoye, Gazprom Neft has other oil production projects and acquisition targets, as will be discussed below.

Gazprom Neft's 51%/49% Joint Venture with Lukoil:

Gazprom Neft signed a joint venture agreement with Lukoil for at least 6 undeveloped oil and gas fields in early 2008 -- details of particular fields in early June, 2008 were undisclosed, but the JV is likely to provide substantial growth opportunities to Gazprom Neft. Lukoil is known within the Russian oil sector as having licences to many potential oil fields, but slow to develop them -- the deal should provide Gazprom Neft with access to Lukoil's potential oil fields. It is tentitively assessed that the Gazprom Neft/Lukoil JV will target the relatively new oil province of Timan-Pechora, which lies over 1000 km to the west of Gazprom Neft's current producing regions, but has tremendous potential. The petroleum consulting firm Blackbourn Consulting has provided a oil and natural gas reservoir map of Timan-Pechora which can be found here. Most of these oil fields are undeveloped -- the larger fields tentively hold approximately 1 billion barrels of oil equivalent in reserves, and the region holds at least 10 billion barrel reserve fields according to the Blackbourn Consulting map. Further detail on the Gazprom Neft-Lukoil JV will be disclosed in late June/early July, at which point field names and data will be better known. At this point the JV points to likely additional reserves of over 1 billion barrels oil equivalent proportional interest to Gazprom Neft.

Transfer of Oil Assets From Gazprom to Gazprom Neft:

The president of Gazprom Neft, Alexander Dyukov, told reporters on June 8, 2008, that Gazprom could put its oil fields on Gazprom Neft's balance sheet by end 2008 ("Gazprom Neft Could Get Gazprom Oil Fields by the End of 2008," Russia and CIS General Newswire, June 8, 2008). Petroleum Intelligence Weekly reported in April of 2008 that Gazprom holds oil fields with 5 billion barrels of possible oil reserves, the majority of which are currently undeveloped (Gazprom Neft's Grand Plans for Growth, PIW, April 28, 2008). Gazprom's undeveloped oil fields lie mainly in the far northern Siberia, in both onshore and offshore locations -- development would be technically challenging, but not prohibitively so. The transfer of oil assets would add significant value to Gazprom Neft.

Gazprom Neft's Potential Acquisition Targets:

The Russian oil firms Russneft, Bashneft, TNK-BP and even Surgutneftegas -- all large oil firms with over 200,000 bpd of oil production -- have been have been mentioned by Russian investment banks as potential acquisition targets for Gazprom Neft. It is the assessment of the author that the full acquisition of any of these targets is not extremely likely -- with the exception of Russneft -- due to factors discussed below. However, one off acquisitions of oil producing assets of these firms is more probable.

Of the names on the list of potential acquisition candidates, Russneft is assessed to be the most likely in terms probability of acquisition by Gazprom Neft -- Russneft is an independent producer of oil in Southern Western Siberia, over 1,000 km from the majority of Gazprom Neft's current producing areas. Russneft's production is approximately 290,000 bpd of oil equivalent (mainly oil) and counts reserves of slightly over 1 billion barrels of oil equivalent, according to Russneft's website. Russneft has been hit over the last year with fines and taxes totaling over 20 Billion rubles, in a move similar to the government's targeting of Yukos in 2004 and 2005. There is a high chance that the ownership of Russneft will change hands, however, what is unknown is which firm will acquire Russneft's oil producing assets once Russneft is in bankruptcy. Reuters reported on 10/24/07 that either the Russian billionaire Roman Abromovich or Mittal Steel -- a Russian steel producer -- were behind the taxes on Russneft, although this has not been confirmed (note that Roman Abromovich was the majority owner of Sibneft, which was the predecessor company to Gazprom Neft, so there could be some connection here with Gazprom Neft). Russian aluminum billionaire Oleg Deripaska has also been rumored to be interested in acquiring Russneft. Overall, summing up these trends, the likelihood of a near to intermediate term acquisition of Russneft by Gazprom Neft is assessed as "moderate."

The acquisition of Bashneft by Gazprom Neft has been also mentioned by several sources, including the Russian investment bank Antanta Capital. According to Antanta Capital, Russian federal (Moscow) authorities have been reviewing the legality of the ownership of Bashneft by the Russian republic of Bashkortostan, and this process is ongoing currently (mid 2008). At stake is the ability of the republic of Bashkortostan to own assets -- currently Bashkortostan -- located in south western Siberia -- has semi-autonomous status, similiar to the Russian republics of Chechnya and Tatarstan. Bashkortostan has its own foreign ambassador and embassy and ethnic group, Bashkir, who speak their own unique language. The outcome of this process is difficult to judge at this point -- if ownership of Bashneft is overturned, then Gazprom Neft would be first in line to acquire the assets, however, it is difficult to say if the Russian government will overturn its long standing (Bashkortostan has had semi-autonomous status since 1992) relations with the republic of Bashkortostan. Probability of the acquisition of Bashneft is therefore assessed as moderately low at this time.

The last two acquisition targets, TNK-BP and Surgutneftegas, are both assessed to be moderately-low to low probability acquisition targets for Gazprom Neft in the intermediate term. While TNK-BP has been hit with tax fines and tax raids over the last year, signaling that it is possible that the government will seize assets, this development is mitigated by the fact that Vladimir Putin personally gave his blessing to the BP-TNK merger early in his presidency. Putin still serves as Russia's Prime Minister and is widely viewed as having significant power, and generally has been known to keep his intentions concerning oil and gas producers. The acquisition of Surgutneftegas by Gazrpom Neft is at this stage merely a rumor circulating in certain Russian publications, and no details concerning concrete facts have been made known at this time. The president of Surgutneftegas, Vladimir Bogdanov, has generally good relations with Putin and Moscow.

Note that even if Gazprom Neft does not acquire 100% of the equity of any of the aforementioned Russian oil firms, it is still possible for Gazprom Neft to acquire individual oil producing fields that are currently owned by these oil producers. In the author's opinion, this scenario is more likely -- also it is the scenario which occurred in the case of Yukos -- Yukos was taxed and fined, then its main producing subsidiary was purchased by Rosneft. Table 2 below gives the names, production and probability of acquisition of the Russian firms that have been discussed in this section.

Table 2: Acquisition Probability by Gazprom Neft of Russian Independent Producers:

2007 production (bpd)

Likelihood of Acquisition (total firm)*

Likelihood of Acquisition (oil field)**




Moderately High













* "Likelihood of acquisition (total firm)" is the author's opinion only, defined as the probability going forward that Gazprom Neft will acquire a majority stake in the independent Russian oil producer.
** Likelihood of acquisition (oil field) is the author's opinion, defined as the probability going forward that Gazprom Neft will acquire an individual oil field from the respective Russian oil producer.


Gazprom Neft has several routes to increase production in line with its planned output goal of 2.0M barrels per day by 2020 -- it is likely that Gazprom's development of South Priobskoye will add a significant percentage of the expected increase of 1 million barrels per day of oil production. In addition, acquisition of existing oil fields from independent producers of oil within Russia is also a probable outcome going forward for Gazprom Neft, and Gazprom Neft's JV with Lukoil is likely to target new, massive oil fields in the Timan-Pechora region with significant potential. Finally, Gazprom's expected transfer of its oil assets to Gazprom Neft should add further value to Gazprom Neft over the long term. All in all, Gazprom Neft has potential to more than double production and increase reserves more than 3 times over its current proven reserve base of 4.5 Billion barrels of oil equivalent.

It should be noted that this article did not discuss taxation issues within Russia -- Russian oil producers pay high taxes on oil production, significantly limited the profits from higher oil prices (although the tax regime favors refiners of oil products, and Gazprom Neft refines a comparatively large percentage of its oil production). Further, risks of asset appropriation by the government was not discussed -- however this risk is mitigated by the fact that Gazprom Neft is majority owned by the government. Interested investors are encouraged to do their own due diligence with regards to these issues.