1. Development of the Oilfield Services Market in Russia Moscow 2-3 December 2003 Yevgeny Bulgakov

2. 2Agenda 1. The Development of the Oil Field Services Market 2. Competitiveness of integrated and independent Service Companies 3. The Development of a «Russia-wide» oilfield service market in the context of the consolidation taking place in the Russian E&P industry 4. The Place of International Service Companies in the Russian Market 5. Conclusions

3. 3 Structure of the Upstream Oilfield Services Market

4. 4 The Evolution of the Oilfield Services Market: TNK-BP Phase 1 Services Internally Owned, Integrated into Upstream Operations Phase II Services Segragated into cost centers within Production Operations Phase III Services segreated into separate business units operated at arm's length from Production Operations Phase IV Service Businesses and Assets Being Divested to Specialized Service Companies Costs established arbitrarily Transfer Pricing Cost plus profit (Benchmarked to external market where possible) Costs set by cost centers Market Pricing All Service Supplied Internally Most Services Supplied Internally Some competition between internal and external service companies Most services sourced Externally 1995-20002000-20022002-20032004 onward

5. 5 Price vs. Quality When are Services Competitive? Service Quality and Technology Service Unit Price Internal Services External Russian Suppliers Multinational Service Companies

6. 6 «Added Value» - A Method of Determing Competitiveness Service Quality Time required to perform service Cost of Service Service Market Divest Hold Hold and Develop Potential Value Added to TNK-BP from utilization of oilfield services Service Quality Time required to perform service Cost of Service

7. 7 General Model of Value Creation for Upstream Operations Upstream Production- related expenditures per year by TNK-BP TNK-BP revenues from oil sales Value Created for ТNК-ВР Average weighted cost of capital for TNK-BP Service Companies create additional value for the Oil Producing companies through: 1.increase/acceleration of ТNК-ВР Revenues (Production) - «S»; 2.overall reduction in ТNК-ВР Expenses (Capex and Opex)– «С»;

8. 8 Value to TNK-BP derived from Drilling Value to TNK-BP derived from Drilling Reduction in completion time accelerates production; quality can improve production Well Completions Quality of cement increases the time between required well service Cementing Operations Reduction in Drilling Time accelerates production Drilling Drilling Fluids Management Reduction in rig move time accelerates production Rig mobilization and moveIllustration Value Added to ТNК-ВР Service

9. 9 Russia’s oilfield services market: As is. Markets for oilfield services are not transparent. Oil companies’ selection processes are biased in favor of in-house service units. Work volumes for competitive tendering are limited. Because external companies have to compete against oil-companies’ units operating as cost-centers, margins are too low to attract new players. Infrastructure and access to auxiliary services are in the hands of incumbents. Bidding and contracting horizon is explicitly short-term, disallowing any sensible equipment upgrades and limiting investment only to quick pay-back projects. Safety factor is undervalued in comparing competing contractors, thus impeding the entry into the market for operationally advanced contractors.

10. 10 Russia’s oilfield services market: As it should be. Oil companies expected demand and expenditure information is shared with suppliers to enhance their investment and planning decisions. Adequate work volumes are available to sustain business for external contractors. Tendering procedures are transparent and consistent with the market policy. Capital-intensive and infrastructure-dependent service markets enjoy long-term contracts. Non-monetary criteria such as safety and environmental awareness become high-priority assessment factors. Truly nation-wide service suppliers exist and operate across the country and across corporate boundaries.

11. 11 «Udmurtneft-bureniye» Established in 1969, Established in 1969, incorporated as an independent business unit in 1998. Revenue Revenue – over $ 50 million per year Geographical Spread of Operations Geographical Spread of Operations – Since 1997 they have operated outside Udmurtia, providing services around Russian and the FSU. They have been offered contracts in countries outside the FSU. Contract Porfolio includes a large number of customers including: Sibneftegas, Pertex, Tatneft, Ritek, Uralsk-neft, Belkamneft, Stimul, Alrosa (diamond mining), etc. Management – Management – operate independently to develop and manage the business. Workforce: over 2000 Capacity and Capabilities Capacity and Capabilities: 30 drilling crews, 23 workover crews, engineering support center, horizontal drilling, cementing, transportation and rig moving, equipment repair, mining related services. Udmurtneft-bureniye: an example of a Russian Service company operating nation-wide.

12. 12 Opening Internal Markets by VICs The Key to the Development of a Market for Oilfield Services in Russia is the willingness of most E&P operators to contract third party services A market with multiple buyers and multiple suppliers reduces risks and costs for all parties –Service Companies can invest in establishment of servcie bases, service capacity and introduction of new technologies to serve multiple clients - reducing costs for all –Mobilization costs are born by multiple clients –Utilization levels for service assets are increased, reducing unit cost of services –Internal Service companies do not need to invest to meet «peak loads» E&P companies can offer some fraction of their service requirements to third party while retaining some internal capability –As third party service companies are able to supply services at a cost and level of quality that meets pre-defined objectives, greater service volumes can be contracted with third parties –Internal Service companies of one E&P operator can provide services to other E&P companies Allows benchmarking Allows evolution of market relationships and skills which can lead to the spin off or sale of the internal service companies at a later date.

13. 13 Federal Oil Field Services Data Base Development of an Objective, Neutral and Reliable source of information regarding Service Suppliers: –Domestic Service Companies –Multinational Service companies operating in Russia Information could include: –Actual Capabilities on the ground for each Service Company in various Regions of Russia –Information on Service volumes performed in each region updated periodically –Some information on performance and service quality Potential Value of the Data Base: –Benchmarking of service performance –Pre-qualification of contractors for participation in tenders –Input to contractor performance management systems –Expedite searches for specific technologies or know-how

14. 14 Multinational vs National Service Companies Generally, internal service companies are benchmarked against and compete with other Russian companies. Some clients even divide the tendered scopes into lots designed for national suppliers and those where global players are expected to win. Even in markets where both Russian and Western contractors are active (e.g. fracturing services) there is a fair degree of job specialisation usually based on the size and complexity of the operation. Therefore, there are clearly two distinct oilfield service market segments with a negligible overlap.

15. 15 Value Generation - Current Situation Service Quality and Technology Value Generation Higher Quality does not necessarily generate more Value Internal Services External Russian Suppliers Multinational Service Companies

16. 16 Why Higher Quality Does Not Necessarily Create Greater Value Usually Imported Services provide the best technical solution and best quality but: –costs of such services are high –mobilisation is costly and difficult –learning curve is costly to all parties –cost to the client of developing (or switching to) a different contractor performance management system is high. A “pure” imported solution may destroy Value rather than add Value!

17. 17 Value Generation - A Possible Outcome Service Quality and Technology Value Generation Internal Services External Russian Suppliers Multinational Service Companies Market solution with Hybrid participants

18. 18Conclusions Divestiture of internal service companies ensures continued market development The development of the services market will enhance competition and enable the creation of more value for the oil and gas producers The consolidation now taking place among Russian oil companies should be followed by the birth and development of nation-wide oilfield service players The oil producers will be looking for hybrid Western/Russian solutions in pursuit of the right balance of price and quality to maximise added value TNK-BP Approach: –Encourage the evolution of the upstream oilfield services market –Encourage other Vertically Integrated Oil Companies to open up their markets to third party service companies –Encourage regional service companies to expand their operational geography –Encourage western service providers to acquire local assets and know-how