No. 2, 2008

Management of expertise sharing among LUKOIL's service companies brings weighty results

Drawing on the experience of ConocoPhillips, its strategic partner, JSC LUKOIL, the leader of Russia’s oil and gas sector, is successfully implementing programs of expertise sharing between its own divisions and service companies, thus adopting a new approach to production process management.

Changeover to external service

World experience shows that the use of external service or outsourcing is more effective and less costly for oil and gas transnationals.

Today, LUKOIL-Perm, one of the Company’s largest subsidiaries, has changed over to external service 100-percent. Efficiency analysis of its activity has revealed that expenditures per pumping well turned out to be а mere fraction of those sustained by other companies.

In 2006, fundamental principles and the strategy of the LUKOIL Group’s intensive growth for 2007-2016 were worked out. In order to ensure the Company’s sustainable development, the program sets tasks for all of its business segments and provides for a continued process of gradually reorganizing and withdrawing auxiliary and oil-specific assets from the structure of the Company’s subsidiaries and changing over to outsourced services so as to increase the Company’s capitalization and to cut oil recovery costs. The volume of workover and PE services is growing continuously. Over the period of 2006-2008, the volume of well maintenance and overhaul services is expected to increase 110%, from 4.5 to 9.6 billion rubles, and production enhancement level is to rise approximately 90%, from 9 to 17.4 billion rubles.

Pioneer well drilling, oilfield equipment repair and maintenance, energy supply, hydrodynamic geophysical exploration, scheduled servicing, pipeline current repairs and anticorrosive protection, transportation, and other services make up the bulk of the oilfield service structure.

Responsibility for oilfield service companies’ management efficiency is growing. LUKOIL attaches great importance to conducting open and transparent tenders for delivery services, to service companies selection quality, and deals with the problems connected with their logistics and personnel status. The key selection criteria are the price, quality and availability of equipment used by service companies, the personnel's skills and relevant experience.

Oil services management efficiency can be enhanced by providing incentives to achieve results over and above the contract targets. For example, a hydrofrac services contract was concluded with a contractor in Western Siberia which stipulated that the contractor would get a bonus on top of the payment for its services if they bring an above-plan increase in oil production.

Expertise sharing – a key to success

Over the past few years, the world’s oil and gas majors have been actively using expertise sharing programs referred to as success story. This expertise sharing technology is also being adopted by LUKOIL based on the experience gained by its strategic partner – ConocoPhillips (USA).

This leading American company has accumulated rich experience in designing and implementing expertise sharing programs. Joint work is in progress now to draw up and implement an analogous software product for the Company’s subsidiaries. Many of ConocoPhillips subsidiaries used to be self-contained, have a rich history and accumulated an enormous amount of expertise. However, following their merger into a vertically integrated company the tools which had been suitable for expertise sharing among individual companies could not be applied to a unified company.

ConocoPhillips has four award nominations in its incentive and stimulation programs, the so-called 4G. Awards in the first nomination (Give) are adjudged to those who have made the largest contribution to work efficiency by sharing their expertise with other employees; awards in the second nomination (Grab) go to those who have made the largest contribution by using the best practices obtained from other employees; awards in the third nomination (Gather) are given to those who actively cooperate with various specialists to embody or use expertise obtained as a result; and awards in the fourth nomination (Guts) go to those who share with others the hard lessons they have learned from their past mistakes.

After a group of experts has given a thorough analysis to the stories gathered, it turned out that their application has brought a profit running into several hundred million dollars. Those success stories described ways to save capital costs, to increase

production and reserves, to cut operating costs and to raise safety engineering standards. The idea was to make employee success stories available wherever necessary. Successes achieved within the framework of sharing expertise having enormous potential for advanced training in productive activity mark a big stride toward raising the standards of business culture through expertise sharing.

Over the past four years, expertise sharing practices saved ConocoPhillips over $2 billion as confirmed by official documents. The saving was calculated on the basis of individual specific examples of employees’ joint efforts retrenching capital and operating costs and boosting oil production.

Using ConocoPhillips’ best practices

As a matter of fact, some elements of today’s expertise sharing mechanism were actively used in the Russian oil industry back in the times of the USSR. Plans for the adoption of new technology and production processes were made, rationalization schemes drawn up and best practice seminars arranged. Therefore, by the time the issue of drawing upon ConocoPhillips’ best practices was raised, some of its principles were already known to LUKOIL’s specialists. Gradually, expertise sharing became part and parcel of our work, and our specialists came to realize that borrowing their colleagues’ best practices really saved time. There is a detailed list of descriptive, quantitative and qualitative information items to be pieced together into a story.

The next practical task which is already being coped with by the Company is to formalize expertise sharing as a regular approach to creating a corporate environment in the Company giving automatic forecast of users’ interests in regard of the information gathered. In all of LUKOIL’s divisions there are several basic levels of expertise sharing. An analysis of real effects expertise sharing can bring has revealed that corporate and more formal support for this work promise still greater profit.

Considering that LUKOIL is a transnational company doing oil and gas business in many parts of Russia and all over the world, it has become clear that there are problems and practices people have in common on a global scale. This applies mainly to groups of experts having enough expertise and experience and making decisions in specific and functional spheres. That was where the development of techniques for drawing up and supporting the Networks of Excellence (NoEs) global programs had its start.

Today, competitiveness in the world oil market takes more than expertise and experience of individual employees. Expert groups engaged in expertise transfer in practically all aspects are becoming an important constituent part of the Company’s work. Any long-term expertise sharing strategy is based on the connection between the groups’ efforts and the improvement of production activities. Expertise sharing brings such positive business results as, for example, a saving of project implementation time, cost reduction, stronger market competitiveness, and improved financial performance.

Information obtained, both positive and negative, makes it possible to exert an influence on service companies, to a certain extent. For example, a customer informed about the efficiency of this or that well repair technology, about the utilization of equipment, tools, chemical reagents and various materials can make decisions and provide recommendations to service companies as to the expediency of the operations in progress. As hydrocarbon resources get depleted in the traditional oil- and gas-bearing regions and new resources are remote and increasingly difficult to produce, modern technology is a major driver of oilfield development profitability.

Moreover, there has appeared an inverse relationship mechanism whereby developers and producers can be informed about the need to remedy shortcomings, to change technical and functional characteristics and properties. This rules out the use of inefficient technologies, substandard materials, low quality equipment and, on the other hand, makes it possible to adopt best practices on the Company scale.

Territorially, the activities of many of Russia’s oil companies sometimes overlap. Hydrocarbons are often recovered in the same oil- and gas-bearing provinces, from the same geological beds with the same stratigraphic sections, occurrence depths and collector structures. In Western Siberia, for example, adjacent oil fields are being developed by LUKOIL, TNK-BP, Slavneft, Surgutneftegaz, Gazprom Neft, Rosneft and many other companies. LUKOIL, Rosneft, Gazprom and other medium and small oil companies are active in the Republic of Komi. The situation is the same in most oil-producing regions. Thus, the use of largely similar oil-producing equipment, special-purpose techniques, tools, chemical reagents and materials further adds to the oil-producing companies’ interest in expertise sharing.

Considering oil companies’ trend toward replacing their own service companies by external ones and their growing role in oil production, the possibility to manage expertise and its effect on oil services is of tremendous importance. Customers and contractors should be, above all, partners in attaining the common objectives. Selection of contractors on a competitive and transparent basis, contractors’ and customers’ common database, sharing of (both positive and negative) experience and expertise as well as the use of various achievement bonus schemes – all of this will undoubtedly stimulate the development of a civilized market of services in Russia’s oil and gas industry.