No. 3, 2004

Pavel Bogomolov


Successful return of Russian oilmen to the Gulf of Suez area

In April 2004, representatives of several investor companies, leading business analysts, and journalists visited Egypt, where LUKOIL Overseas Holding Ltd is implementing a number of upstream projects. The visit program started with a business seminar on Egypt's oil and gas industry prospects.

Symbols of the past and signs of the present

The seminar for investors and the business press, organized by LUKOIL Overseas Holding Ltd. in Marriott Mirage City, a fine hotel near Cairo, focused on revitalizing Russo-Egyptian cooperation. In his speech, the Egyptian Minister for Petroleum Sameh Fahmi spoke about two periods - the 1950s-1970s, when Moscow actively helped Cairo defend its independence, sovereignty, and lawful rights to the Suez Canal, and the present, emphasizing the need to revive cooperation between the two countries in a peaceful and competitive environment, on a mutually beneficial basis, and to demonstrate in practice that Russia and Egypt have a lot more in common than is usually believed. Russia is independent in its energy policies, while Egypt has to follow OPEC's decisions, nevertheless the two countries' positions, with certain differences, are generally quite similar.

"The most convincing symbol of bilateral cooperation is the Aswan High Dam on the Nile", the Minister said. "That symbol is quite unique and so far unparalleled. But I do hope that some day it is matched by our partnership in oil and gas production. It does not yet meet the expectations of the two countries' governments and peoples. But things are rapidly improving. And the core of that process is cooperation with LUKOIL". According to the Minister, natural resources should be a major factor of relations between Cairo and Moscow. Both nations are interested in having the increasingly frequent regional oil and gas meetings translated into a truly global, efficiently structured energy dialogue. LUKOIL, the first Russian company to move into the present-day oil industry of Egypt, focuses on deeds rather than words, the Minister said. Experimental cooperation in oil exploration between Egypt and LUKOIL is supplemented by partnership in production operations.

Major oil production in Egypt - is that a serious prospect?

"Over the past few years, our company has developed from an investor to an operator", Andrey Kuzyaev, President of LUKOIL Overseas Holding Ltd., said at the seminar in Cairo. "If our current projects are successful, our total investments in Egypt will increase to $400 mln. and we will be producing up to 10% of Egypt's total oil. Besides, we will do some gas production projects. Overall, I can say that a dynamic and steady consolidation of our business positions in Egypt is a purposeful strategy. This country is one of the most attractive locations for foreign investors, in terms of political stability, oil and gas reserves, tax environment, and overall financial transparency. This partnership is justified and has good prospects, - that's why Egypt is among top priorities of LUKOIL Group's global strategy".

Thus, Egypt - a country with an ancient history - and oil… How come this still sounds like an unusual combination? The main reason is that Egypt cannot be a leading exporter of oil, like the Persian Gulf nations. The country's population is 70.7 mln. and rapidly growing, so more and more energy is consumed domestically and more and more fuel has to be sold at local gasoline filling stations at subsidized low prices. That is why Egypt is not a major supplier of crude oil to Asia, Europe, or America, like Saudi Arabia, Kuwait, or the United Arab Emirates. Although producing only 735,000 barrels of oil a day, Egypt has huge reserves, at least 62 bln. barrels of oil equivalent, with a reasonable upside potential.

Speakers at the seminar in Cairo were the top managers of Egypt's oil companies: Ibrahim Saleh, Chairman of the Egyptian General Petroleum Company (EGPC), Hassan Akl, Chairman of the Egyptian Oil Holding Company South Valley (GANOPE), Mohammed Ibrahim Tawila, Chairman of the Egyptian Natural Gas Holding Company (EGAS), Sherif Ismail, Chairman of the Egyptian Petrochemicals Holding Company (EPHC), Ahmed Dervish, Chairman of the oil company Tharwa (Egypt), and others. They said the industry expected domestic and foreign investments totaling $6.2 bln. over the next five years, naming British Petroleum, British Gas, Petronas, LUKOIL, and several other companies of the United States and other countries as potential investors.

A gas pipeline to Jordan alone will cost $240 mln., and it is planned to ship LNG to Spain starting in the next few months, to France starting in 2005, and to Italy and the United States in the longer term. In the domestic market, an extensive restructuring is expected, and 100,000 motor vehicles planned to be converted to gas by 2007.

Egypt gives priority attention to petrochemical industry. According to the management of the Egyptian Petrochemicals Company - one of the country's recently established government-owned companies, 24 projects to be implemented in the next 20 years will require at least $18 bln. in investments. It is planned to produce 15 mln. tons of petrochemical products annually, mainly from gas, in order to save $3 bln. currently spent on imports of plastics and to earn $7 bln. in net profit for the national budget.

LUKOIL is headed for a PSA

Speaking at the seminar, Sergey Nikiforov, Regional Director of LUKOIL Overseas Holding Ltd., pointed out that Egypt held 20% of Northern Africa's hydrocarbon reserves. However, the country's production figures account for smaller percentages of the region's totals: 16.8% for oil and 18% for gas. Egypt, along with Algeria and Libya, has the most coherent and transparent investment rules in the whole region from Gibraltar to Suez. LUKOIL has been able to use the opportunities available to acquire an asset portfolio combining mature and declining fields and newly developed ones. As a result, LUKOIL's Egyptian operations have been enviably stable and even growing at a steady rate.

In the Meleya field in the north-west, LUKOIL has a share of 12% and owns 7.5 mln. of oil reserves; the rest of the project is owned by Agip (Italy), which is the project operator and a joint venture partner of LUKOIL, the International Egyptian Oil Company, and the International Finance Corporation. This is a declining production field, so LUKOIL's share of reserves is shrinking. Nevertheless, LUKOIL's share of Meleya oil production totaled 640,000 barrels including royalty in 2003. In physical volume terms, production was 5% down from 2002, but, due to higher prices, the revenue totaled $10.514 mln., up from $9.544 mln. in 2002.

The field has 61 operating wells, with flow rates averaging 34.4 tons a day, the water content is 31%, and oil density, 0.856 g/cm3. In financial terms, Sergey Nikiforov pointed out, the project is long past the payback level.

As for the fields of North-Eastern Geisum and Western Geisum, with probable oil reserves estimated at 228.4 mln. barrels, they are still in the exploration phase. Bidding procedures are under way to select contractors to re-process seismic data and to perform aerial magnetometer surveys. LUKOIL expects the initial phase to be successful. Oil production is scheduled to commence in 2007, to reach a peak of 10 mln. barrels two years later. North-Eastern Geisum and Western Geisum are both located offshore in the Gulf of Suez, quite close to the Zeit Bay and Ras El-Bahar onshore infrastructure facilities. Therefore LUKOIL - currently the project's investor and soon the only operator - expects no problems producing crude oil, delivering it to shore, and transloading it for further transportation.

The WEEM project, near Khurgada, is already fully operated by LUKOIL, which is entitled to 16.6 mln. barrel of its reserves - half of the field's total, the other half to go to the Egyptian government. The field has 17 operating wells, with flow rates averaging 94.4 tons a day, the water content is 22.1%, and oil density, 0.896 g/cm3. After primary treatment, oil is delivered to a tank trucking company, which takes it to a gathering main connected with a national pipeline system. But this summer trucking will be replaced by a newly-built dedicated local pipeline.

Egypt cooperates with LUKOIL and other foreign investors under production-sharing agreements, which the nation sees as the most reliable and proven tool of increasing production as well as exploring new reserves and rapidly adopting new oil production processes. This mainly refers to the Western Desert, which has a lot more reserves than was believed until quite recently. Combined with the offshore gas fields in the Mediterranean, this explains why Egypt hopes to generate significant revenues in the immediate future and then, as forecast by Egyptian experts, to move on to more costly projects in cooperation with foreign companies, including LUKOIL.

From a regional strategy to a global one

The seminar's results were aptly summed up by Andrey Kuzyaev, President of LUKOIL Overseas Holding Ltd., in his report entitled ТLUKOIL in Northern Africa and the Middle East: From a Financial Investor to an International Operator.У The report actually focused on the overall upstream strategy outside Russia. Andrey Kuzyaev mentioned LUKOIL's intention to increase its international oil production to at least 12% of the corporate total and later to 20%, which would account for 30 to 35% of the company's upstream profits. LUKOIL, much like the major international oil-industry players, has been diversifying its operations geographically, with upstream projects currently implemented or planned in the Caspian, Central Asia, the Middle East, Northern Africa, and, very probably, Latin America. Besides, LUKOIL plans to increase gas production to account for 40% of its international project production. The objectives, as described by Mr. Kuzyaev, include ensuring project profitability levels of at least 15% and obtaining operator or cooperator rights in at least half of the new international upstream projects (to go up to 70% by 2013).

These plans are quite realistic, since LUKOIL's production overseas grew by about 20% per annum in the past five years. Oil production costs were never higher than $1.6 per barrel in the past three years, and proven reserves reached 10 bln. of oil equivalent. In order to maintain these positive momentums, it is planned to improve overseas operation teams' performance and to manage corporate assets more efficiently - by selecting reliable partners and sharing risks with them, for example, by selling interest in active projects, preferably at the exploration stage.

"The cost of increasing reserves through exploration outside Russia has been two-thirds of acquiring reserves", Mr. Kuzyaev stressed. "But that does not mean, of course, that our cost reduction efforts can now be slackened; on the contrary, these efforts must be maintained, and the best solution is to share risks in our seven exploration projects. In 2004-2006, we will sell interest in the Condor project in Colombia and in our project in Saudi Arabia; importantly, however, we will keep the operatorship in both projects. I am confident that we will find partners, because in most petroleum producing countries LUKOIL has a high 'A' rating as a corporate investor".

As it seeks operatorship, LUKOIL is fully aware that it should have adequate skills and expertise available outside Russia. LUKOIL personnel seconded from Russia to its operations in other countries increased five-fold over the past few years and will reach 2,000 by 2013, net of local employees. These figures are comparable with employment schemes of the world's leading international companies. Illustrating the "healthy aggressiveness" of LUKOIL's plans, Andrey Kuzyaev provided only one example, Exploration Block A in Saudi Arabia allocated to LUKOIL, but that block equals the territories of some Middle East countries.

"We decided to be very active in that bid", Mr. Kuzyaev explained, "not only because of the impressive resource base. There was another reason - to move into a country where Russian companies remain virtually unrepresented was very important. We made major commitments - to invest $215 mln. over five years, drilling 9 wells and running extensive seismics. The expected payback period is 8 years. If reserves are discovered, 150 km of pipeline will have to be constructed to reach the Saudi national pipeline system. We do hope the field has gas and condensate, not just gas".

All in all, there are lots of plans, intentions, aspirations, and expectations. Geographically, they all originate in Egypt. That country's mineral reserves are used by LUKOIL to refine and test many corporate solutions, whose results may be seen in the not-so-distant future in Egypt as well as other countries and regions thousands of miles away.

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Oil of Russia, No. 3, 2004
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