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Independent Contractors Account for Only 30% of Russian Oil and Gas Construction

INFOLine, July 5, 2013


In the Russian market of general contracting services for oil and gas companies, two types of contractors prevail: the subsidiaries of state-owned monopolies and the subsidiaries of the strategic contractors of state-owned corporations. According to an INFOLine study, "Investment projects and engineering in the oil and gas industry of Russia", up to 70% of the funds allocated for construction in the oil and gas industry are used by divisions of Transneft, Gazprom, and holding companies which control engineering assets that have been divested from government monopolies.

The largest general contractors for construction in the fuel and energy sector are the companies Stroygazconsulting and Stroygazmontazh, which fulfill orders for Gazprom and account for the largest shares of the oil and gas budgets for the development of oilfields and the construction of pipeline systems.

The main trend in the development of the market for fuel-and-energy sector engineering in 2012-2013 was the strengthening of the position of companies controlled by Gazprom and Rosneft, along with the companies Stroygazconsulting and Stroygazmontazh. AK Transneft created Transneftstroy, Ltd. which in just four years of operations became one of the top five general contractors in the industry, while a subsidiary of Gazprom, OJSC Tsentrgas, generates revenues of over 700 million dollars a year.

This process is among other things attributed to the nationalization of the oil industry, the major milestones of which were:

• The appointment of the head of the Ministry of Energy Igor Sechin as President of Rosneft (May 23, 2012) and the Chairman of the Board of Directors of Inter RAO UES (June 25, 2013)

• Rosneft and Gazprom securing the exclusive right to develop the offshore fields, according to the Federal Law "On Subsoil" (May 7, 2013)

• The acquisition by Rosneft of TNK-BP Holding in 2012 and of Itera in May 2013

The conversion of Rosneft into one of the largest public oil companies in the world, which has the capacity to attract foreign partners to develop Russia's offshore hydrocarbon deposits, has created a stir among international companies. Rosneft has already signed agreements with ExxonMobil, Eni, and Statoil to develop offshore oil and gas in the Kara and Barents Seas, the Sea of Okhotsk, the Chukchi Sea, the Black Sea and the Laptev Sea. For the largest construction companies in Russia, it creates new opportunities for the development of new competencies among Russian contractors and suppliers, as Rosneft has declared its intention to maximize the use of them. At the same time, the vast majority of Russian players in the construction industry lack the experience necessary for such projects, and their lack of equipment and technology will be a barrier to their participation in the development of the shelf. The high risks associated with working on the shelf and financing the work from the standpoint of foreign investors may become a stumbling block in the negotiations between oil companies and their partners and determine the necessity of attracting foreign full-cycle engineering companies in projects to complete engineering, procurement and construction contracts.

At the same time, the strategy of market leaders reflects a desire to diversify their portfolio of orders, due to the inclusion of energy facilities and infrastructure construction. The reason for entering new segments was the accumulation of competencies, the expansion of resource potential and the desire to minimize risks in the completion of several major Gazprom projects. In addition, more and more large Gazprom contracts are not only being fulfilled by Stroygazconsulting and Stroygazmontazh, but by other market participants. A typical example is the victory of CJSC Stroytransgaz (previously Argus Pipeline Service) in March 2012 in a tender for the construction of the second line of the Bovanenkovo–Ukhta gas trunkline network and in the summer of 2012 the company acquired a contract to build the Kazachya compressor station, a basic component of the Southern Corridor pipeline.

The ability of such companies to win major contracts is increasing due to their experience and competence in the energy industry and in connection with the reform of the procurement system of state corporations and the increased attention of Russia's federal antimonopoly service to the way in which contracts are chosen. This has compelled Gazprom to adopt a more mindful approach to its selection of contractors and caused it to avoid contracts that are passed through chains of middlemen. The reform of legislation in terms of public sector enterprise procurement is being carried out in compliance with Federal Law #223, dated July 18, 2011, "On the procurement of goods, work, and services by separate types of legal entities" (which was put into effect on January 1, 2012), which establishes general principles and requirements for providing information about company purchases among companies in which government enterprises (including Russia’s federal, regional and municipal governments) own more than 50%. State corporations were charged with the duty of providing exhaustive information on their planned procurement activities on the site starting January 1, 2013.

The ability of such companies to win major tenders is increasing due to their experience and competence in the energy industry.

In the medium-term, "second-tier" Russian companies will experience increased competition from international engineering groups, the expansion of which into Russia has so far been restrained by the regulatory constraints of the energy industry as well as technical regulations in the construction industry concerning hazardous industrial facilities, developed market projects, and competition from established construction firms and service providers in the fuel and energy sector's key regions.

Independent Russian and foreign engineering companies provide about 30% of the contracts for oil and gas construction, mainly performing subcontracting for relatively small amounts of work (Russian companies), or acting only as equipment suppliers and licensors of technology (foreign companies). Such companies cannot obtain or implement a comprehensive EPC contract, either because of the insufficient scale of their business or due to their lack of experience in implementing large-scale projects in Russia.

Among the independent companies which market engineering services to the oil and gas industry, those that are developing the most dynamically are Globalstroy Engineering (which was divested in 2004 from Lukoil Group), Velesstroy, and Stroynovatsiya, which is owned by Ziyavudin Magomedov's Summa Group. Furthermore, in the medium term, CJSC Stroytransgaz and RusGazEngineering may demonstrate rapid growth in turnover:

CJSC Stroytransgaz is a joint venture established in a collaboration between Argus Pipeline Service (Argus Group) and OJSC Stroytransgaz. Argus Pipeline Service was renamed CJSC Stroytransgaz in anticipation of the planned sale of Anton Michael Rae's blocking stake to entities owned by Gennady Timchenko. The transaction may take place before the end of 2013; the details of the transaction have not been disclosed.

RusGazEngineering GC has been working in Russia's oil and gas engineering and construction market for more than 10 years; it was divested from Gazprom in 2006, and it is actively pursuing full-cycle engineering projects. It has increased the size of its construction staff and amount of equipment since 2011, and started developing activities outside Russia.