Graham Stack in Moscow -

With oil prices hovering around $100 a barrel and field depletion causing production growth to flatten, companies are desperate to get as much oil out as possible and to break ground on greenfield sites. All of this is music to the ears of oilfield service companies, which are busy raising money to meet this demand.

Imperial Energy announced at the start of February it was considering an IPO of its freshly consolidated oilfield services arm Rus Imperial Group. This followed hot on the heels of an announcement at the end of 2007 by TNK-BP Holding that it would consolidate its drilling assets into a unified oilfield service company, with an eye to spinning them off into a company with annual revenue of $500m-600m and a market capitalization of about $1bn-2bn.

Another oilfield service spin-off, formerly Lukoil Burenie but now Russia's largest independent such company Eurasia, raised $450m through an IPO in November 2007. And the former Yukos oilfield service subsidiary, the now-independent Siberian Services Company, launched in February a roadshow to promote a $200m bond to fund new projects in Siberia and Uzbekistan.

"Spin-offs are an ongoing story," says Deutsche Bank's Olga Danilenko.

And one that is set to continue. The depletion of Russia's ageing oilfields means production growth has flattened out at 1-2% per year. The subsequent poor results from Russian oil companies contributed to the stock market's shocking year in 2007. But with oil prices now at around $100 a barrel, these companies are desperate to raise production, causing oil sector capital spending to soar.

"The market is booming and driven not so much by high oil prices as by the decade of production collapse following the end of the Soviet Union," says Danilenko. "The 'oil miracle' that subsequently took place, took place with recovering production that ran into trouble in 2006 with a decrease in efficiency. Basically, it's getting harder and costlier to extract oil in Russia, and this is why oilfield services are becoming increasingly important."

Danilenko argues that this means any fall in oil prices won't impact on the boom. "The reasons for the growth in the sector are deep and fundamental, not so linked to the price of oil, and there is a sliding tax rate."

According to UniCredit's Tatiana Kapoustina, oilfield services are entering a new upward cycle. "Russian [oilfield service] segments have suffered from two decades of underinvestment. Around 72% of rigs are over 10 years old. Shortage and aging of drilling rigs point to a boom in manufacturing."

As a sign of the times, top Lukoil manager Leonid Fedun stated in December that Lukoil's capex for 2008 would hit just under $10bn as the first step in a plan to double oil production over 10 years. And also in December, TNK-BP completed Russia's biggest ever oilfield service tender, for a total of $3bn worth of contracts over three to five years.

All this points to huge growth until the end of the decade. An independent Douglas-Westwood report points to the Russian oilfield service market roughly doubling in size by the end of the decade, to $22.5bn from $11.6bn currently.

Industry consolidators

For investors, the good news is that the industry is likely to consolidate around the listed companies. "There's going to be a wave of M&A, because the sector is so under-consolidated, although the wave might peak in 2009 rather than 2008," says Danilenko.

According to Renaissance Capital analyst Roman Eleagin, within five years some 70% of services will be outsourced by majors to independent companies, in contrast to the current less than 50%. Around half of independent companies are "small- and mid-sized companies destined to disappear," reckons Eleagin.

Integra has led the way to date in M&A, with a track record of 24 acquisitions that began in 2005, making it today "the only truly integrated name in Russia and currently the only consolidator in the industry," says Kapoustina. Although only incorporated in 2004, after a two-year shopping spree Integra now has an overall 4.6% share of the oilfield service market in Russia, and dominates the heavy rig manufacturing segment (67.8%), and leads in seismic and logging (14.6%).

Integra's IPO in April 2007 brought in around $600m, and with Eurasia richer by $450 since its IPO, these companies have significant war chests to power the industry's consolidation.

Another listed company looking to diversify into an all-round provider is C.A.T. Oil, which currently leads the high-margin hydraulic fracturing niche, the main Russian provider of this advanced technology, competing with multinational Schlumberger. According to Danilenko, 2008 should see C.A.T. oil breaking into the "league of diversified service providers," expanding its services to include drilling and geotechnical services, which should in the future account for over 50% of its business.

Integra was even said to be looking for acquisitions abroad in 2007, in particular in China. However, argues Eleagin, Russian companies already have their work cut out for them in Russia, so are unlikely to engage in any major foreign expansion programmes.

Meanwhile, the operations in Russia of multinational companies such as Halliburton and Schlumberger are currently not impinging much on Russian companies. "International companies focus on high-end services, this is their niche," says Damilenko.

Renaissance's Eleagin is more bullish about the Russian players. "It is not a question of whether Russian companies will be able to compete with foreign players - they already are competing."

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