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How to Turn Around a Failing Oil Company

mbkwef041008.jpgMichael J. Economides and Donna Marie D’Aleo have written an important chapter for a new Energy Report published by Transitions Online, which takes a comprehensive look at the early legacy of Yukos – even going so far as to tell the story of American oil experts Joe Mach and Don Wolcott, who came aboard to help the company in the 1990s to turn around its production miracle. Many people forget that when Mikhail Khodorkovsky acquired Yukos, the company was unprofitable, on the brink of bankruptcy, saddled with debts, and producing below 10% of capacity. Under his management and the technical expertise to these men, they turned around a declining oil company to achieve 20% growth in production annually for three years. Economides and D’Aleo write “Such a feat has never been seen before, nor is it likely to be repeated by any oil company, anywhere.” Here is just an excerpt from the article, and below the full text:

There is an interesting and telling story about the Khodorkovsky/Yukos saga. We conducted an informal (and admittedly non-scientific) poll of 30 Russian oil executives, both native and expatriate, for this book, asking: “What was Khodorkovsky accused of?” Without exception, all answered tax evasion or fraud by Yukos. In fact that was not the case. The criminal charges against Mikhail Khodorkovsky were based upon claims that he acted illegally to acquire a fertilizer company known as Apatit during its privatization in the 1990s. All did acknowledge that his fate had nothing to do with anything other than the hubris Khodorkovsky demonstrated toward Putin. There it is then. If punishment is intended to serve as deterrence for others, this punishment served its purpose. But this was not the traditional notion of justice preventing a similar crime, but rather this: insult the powers that be, and receive your comeuppance in return.


From TOL:Turning Around a Supertankerby Michael J. Economides and Donna Marie D’Aleo10 April 2008The post-Soviet emergence of oil giant Yukos is a tale of desperation and bright ideas, but no happy ending.This excerpt from the forthcoming book From Soviet to Putin and Back: The Dominance of Energy in Today’s Russia is the ninth in a series of articles from the TOL Special Report: Energy.Also see: THE BALANCE OF POWERMikhail B. Khodorkovsky had been CEO of Yukos since the company’s creation, but over its first six years had not had a single profitable year. Until 1999, the oilmen in charge continued the same practices they inherited from the past: more drilling, pasting over glaring problems, refusing to enhance well production selectively, and failing to invest in new technologies or new equipment. Many wells were producing at pitifully low levels, and even more lacked adequate well completions or pumps to lift the oil to the surface. Yukos was in a financial bind and was months behind on payroll. Debt was piling up, and lenders were pressing for repayment of loans. Khodorkovsky was the first Russian oilman to realize that business as usual was not going to work for the company.Fatefully, at that very time, two American expatriate engineers crossed paths with Khodorkovsky’s company.Joe Mach was already a well-known petroleum engineer and manager in the international petroleum industry. He joined Yukos in December 1998 after some 30 years of experience with Gulf Oil and Schlumberger. Mach, trained at Tulsa University, had a rare combination of talents. He had an excellent technical background and a shrewd instinct for production, cultivated over the years, that was (and still is) hard to find among managers in the international oil industry. Generally, those who climb the management ladder tend to downplay their technical training and relegate tasks to subordinates. Such is not the case with Mach, who had other rare talents: an instinct for production enhancement and the ability to see the best solution to problems and cut through the complications that often blind others.Mach had gone to Russia some time earlier as a senior Schlumberger executive. He resigned in late 1998 and joined Yukos as vice president of production, essentially running exploration and production.Sign of the times.In early 1999, Russia, and Moscow, for that matter, was a tough place to live. In August 1998, a disastrous ruble devaluation and banking crisis essentially destroyed the economy. Shortages were rampant. Although the situation was a little improved from the early 1990s, the ruble was still practically worthless, and, for the most part, dollars were the acceptable tender for personal or business transactions. This crisis leveled some of the squabbling oligarchs and their financial and industrial groups.Khodorkovsky’s empire was one of the biggest and most infamous; it was seriously injured, but it survived. The finance sector, which had been the basis for wealth and the sweetheart of Russia’s oligarchic capitalism, was eclipsed by the oil industry and the mass media as the key to power. While Khodorkovsky got his start in the pseudo-banking of the last days of the USSR, he had diversified into oil.So, in January 1999, Joe Mach summoned Don Wolcott, who had worked for various companies, including ARCO in Alaska and elsewhere, and Schlumberger. With a Ph.D. in petroleum engineering from the Colorado School of Mines, Wolcott had made a name for himself as a water-flood expert, and had qualifications that Mach liked: field experience, an advanced education, and stellar technical credentials.Wolcott tells the story like this. In his usual no-nonsense way, Mach gave him a summary of the situation, and it was bleak. Yukos had more than 14,000 active oil wells producing an average of 58 barrels of oil per day (8 tons/day), and about 4,700 injection wells injecting on average 200 barrels of water per day. Those sounded like good rates, compared to the ones in the United States, until Mach told him the average fluid level was 1,310 feet for the typical 8,200-feet deep well, and that pumps were set too shallow at a depth of 3,940 feet. Why weren’t the managers producing their wells more effectively? Production rates per well were less than 10 percent of potential.The problem with 13 years of production decline, Mach concluded, was not damaged wells and reservoirs, but poor production and water-flood technical management. Many considered Russia a mature province that had seen its production peak in the 1980s. Most “experts” believed this was caused by bad well intervention (“workover”) and drilling practices, which damaged wells and exacerbated reservoir damage due to “over-production.” It was obvious why Mach had invited Wolcott to Russia.Instead of continuing to drill 1,000 wells per year, as was the previous practice, Mach and Wolcott proposed to Khodorkovsky that Yukos abandon its focus on drilling expensive wells and instead concentrate on production enhancement of existing wells, using existing facilities and selecting candidates carefully.This must have been music to Khodorkovsky’s ears, because reducing the Yukos capital expenditure would be not only welcome, but necessary. The company was very near bankruptcy and had not paid many employees in months.Khodorkovsky was all too eager to try new things. From the company’s inception in 1993, as production fell by 250,000 barrels of oil per day, 1,600 new wells were drilled. And yet the old Soviet-trained field management constantly asked for more and more wells to be drilled at increasing costs, all while production was declining. That’s the way it had been, and that was the only way they knew.Mach’s background as one of the world’s best in production enhancement was invaluable. He recognized that existing wells could be stimulated to produce closer to their potential, and it would not take much to double or even triple their performance. Drilling could be cut substantially while production would increase; a stunning departure from past practices, and one that defied traditional Russian logic.By February 1999 Mach and Wolcott had set the foundation for Yukos’ transformation, which became legendary in the international petroleum circles. They went to Tomsk, in Siberia, one of the main Yukos oil towns, and started training a handpicked group of young Russians. Mach and Wolcott never distinguished the task of running the actual operations of the company from the role of technical trainer.Eventually, they brought practically every well-known petroleum engineer into Russia for repeated visits and developed a cadre of young Russian engineers (themselves part of the growing legend) who after the collapse of Yukos formed the backbone of modern Russian petroleum enterprises, including practically all producing and service companies. …The production enhancement initiative that Mach and Wolcott started was wide in scope and huge in size. The program established concrete actions to be taken every day. Each specialist was assigned a specific operating unit in the company, and given the task to rank the wells from biggest to smallest in relation to potential enhancement. With this information, they prioritized work on the best wells first.“Pushing the limits” became a mantra for the company. The technique of hydraulic fracturing, well established worldwide, had atrophied in Russia, even though technically Russia was its birthplace. Within four years, Russia became the hotbed of hydraulic fracturing activities, second only to the United States in volume of activity, but considerably superior in terms of the quality of work, materials, and technologies used. Yukos led the way, and soon many other companies followed suit, headed by Sibneft and TNK.It was not just production enhancement, though. In May 1999, Mach and Wolcott were in Nefteyugansk, Siberia (Yukos’ largest operating unit) teaching 40 new trainees water-flood pattern management. Wolcott focused on supporting the production enhancement activity with pattern-level calculations, a technique perfected in some of the best-run fields in the United States. Bad or badly positioned wells were shut-in, wells were converted from producers to injectors, and the program was updated on a daily basis, constantly improving the efficiency of the operation and looking for improvements.The results were spectacular. Following the decline from 1986 … to 1999, the trends were reversed, and for the subsequent four years production increased by about 20 percent annually, from 890,000 barrels per day in 1999 to almost 1.8 million barrels per day by 2004.Compared to Sibneft, the next best in class, Yukos’ rate of production increase was substantially better. … Compared to the more traditional Russian-style company, Lukoil, the results were positively thwarting. … Starting at about 60 percent of Lukoil’s production in early 2000, Yukos caught up by late 2002, and was by far becoming Russia’s best performing oil company.Compared to all Russian companies, Yukos was doing better in a number of important indicators, such as incremental production added, … and because it selected drilling candidates, by drilling fewer wells and enhancing production of existing wells the company’s efficiency (e.g., in incremental production per meter drilled) was far higher than any others. …All this was done by reducing the active well count from 14,000 wells in 1999 to 8,000 by 2003, while increasing recovery from 33 to 42 percent and reducing [the percent of water in total liquids produced] from 77 to 69 percent.Even more impressive were the company’s costs of oil production and exploration, in dollars per barrel. The “production costs” and the “finding and development costs” graphs show Yukos at the lowest position, not just of Russian companies, but of all major multinationals, in both production and exploration costs.Such a feat has never been seen before, nor is it likely to be repeated by any oil company, anywhere.By early 2003 Mach and Wolcott, although understandably proud of their work, were not yet satisfied, knowing how much more could be accomplished. Supported by Khodorkovsky, they wanted Yukos to compete in the international arena with the “big boys”: Exxon Mobil, BP, and Shell. They showed that Yukos’ successes were still less than what could be accomplished, and they repeatedly credited Khodorkovsky for letting them “do their thing” in a way that would have been squashed by less enlightened management in the best-known multinational oil companies.Of course, Yukos’ success as a spectacularly well-performing company would never come to pass.In October 2003, Khodorkovsky was arrested. In the months and years that followed, the assault on Yukos by the government was unrelenting, with the company ultimately taken over by the state, and its assets divided among the state-owned and state-dominated oil companies.Khodorkovsky was by no means a saint. … But the vehemence against him and his company is without parallel in the modern, presumably transparent, business world.And it did not end there. In early 2007, shortly before Khodorkovsky was eligible for parole from his Siberian prison, new and graver charges were brought against him for embezzlement and money laundering. In a February 2007 “white paper,” Robert Amsterdam, of the Amsterdam and Peroff law firm in Toronto (Khodorkovsky’s “Canadian lawyers”), wrote: “The new proceedings against Mr. Khodorkovsky are a miscarriage of justice, in the context of a system of total injustice. There is nowhere in Russia that this defendant can have a fair trial, because those who have the power to control the legal system have an interest, both materially and personally, in the finding of guilt.”There is an interesting and telling story about the Khodorkovsky/Yukos saga. We conducted an informal (and admittedly non-scientific) poll of 30 Russian oil executives, both native and expatriate, for this book, asking: “What was Khodorkovsky accused of?” Without exception, all answered tax evasion or fraud by Yukos. In fact that was not the case. The criminal charges against Mikhail Khodorkovsky were based upon claims that he acted illegally to acquire a fertilizer company known as Apatit during its privatization in the 1990s. All did acknowledge that his fate had nothing to do with anything other than the hubris Khodorkovsky demonstrated toward Putin. There it is then. If punishment is intended to serve as deterrence for others, this punishment served its purpose. But this was not the traditional notion of justice preventing a similar crime, but rather this: insult the powers that be, and receive your comeuppance in return.Michael J. Economides is a professor at the University of Houston’s Cullen College of Engineering. He is also the editor in chief of Energy Tribune magazine. Donna Marie D’Aleo is a doctoral candidate in world politics at the Catholic University of America in Washington, D.C. Economides spent four years as an adviser and training developer for Yukos, working with Mach and Wolcott.