Keeping Russia in reserve

FRIDAY INTERVIEW:DENNIS FRANCIS  chief executive, Petroneft

SHAREHOLDERS IN any company almost always have something on their minds, and they don’t often get the opportunity to collar the chief executive and ask him about it. But at the extraordinary general meeting of oil exploration group Petroneft last Monday afternoon, chief executive Dennis Francis, to his own surprise, did not face any questions from the floor following his progress report on the company’s various exploration licences in Russia.

Shareholders had earlier approved the motions needed for the second tranche of the company’s €31 million share placing.

It would be presumptuous to draw any conclusions from the shareholders’ reactions, but, even after a 2 per cent dip on Wednesday, the company was quoted at 56.88 pence sterling in London, over 30 per cent ahead of the 43 pence placing price announced last month. Not too many grounds for complaint then.

When Petroneft announced the fund raising last month, some estimates of the company’s likely value ran to about 71 pence, leaving another 25 per cent or so of headroom on Wednesday’s close. That kind of premium, and the fact it is producing oil and stepping up exploration in an area of Russia where reserves were identified as far back as the Soviet era, have led to speculation that it could be a takeover candidate.

Francis makes it clear early on that while he has to be conscious of shareholder value, selling is not the aim. “We’re certainly not a bunch of lawyers that are just putting a bunch of acreage together to sell it,” he says. “We’re very selective in what we’re doing. Because that’s what we do – we develop oil fields.”

But he does think Petroneft is undervalued and as along as that persists, it could be seen as a takeover candidate. “That was one of the things behind going out and raising this money: to accelerate our exploration programme,” he explains. “If you can triple your reserves by drilling five wells, you should drill those wells as quickly as you can or somebody else is going to take you out and drill those wells for you.”

He means it when he says “selective”. Petroneft is focused entirely on two exploration and production licence areas, 61 and 67, on either side of the Ob River in the Tomsk Oblast region of southwestern Siberia. On a map, they look like two small rectangles in the vast expanse of Russia and the former Soviet Union. But that’s a little misleading.

Licence 61, from where the company is shortly due to start producing 4,000 barrels a day from a field at Lineynoye, is the size of 25 North Sea blocks, and is less exploited to a vast degree. Its other licence, 67, could potentially hold 55 million barrels, according to data collected by Russian authorities.

Nevertheless, Petroneft is still what Francis describes as a niche operation. It is focused on Russia, and while the recent fund raising gives it the scope to spread its wings, Francis is not interested in straying too far at this stage. He points out several times that the company is built around its familiarity with the country, and with its opportunities.

For the moment, it makes sense. All going well, production at Lineynoye, teh northwestern part of Licence 61, will increase to 12,000 barrels a day from next year. Meanwhile, last week it found oil in its Arbuzovskaya prospect, which is close to Lineynoye. Given that it made the discovery at the start of its planned exploration programme and just days before its shareholders’ meeting, the company could hardly have timed it better.

Petroneft’s strategy is to “pick off” smaller assets in areas where oil has been identified. The Soviets explored, but didn’t get around to exploiting much of Tomsk, so there is a lot of existing information and data on the region.

The company’s staff are Russian, and know not just the lie of the land, but also the ins and outs of dealing with a system that still has some elements of the old Soviet bureaucracy. “They do things just the way we want them done,” he says.

Over the last year, the company has built its own pipeline to link up with the existing infrastructure in the region, which means it can get its product from underground to the market. Much of this work is done in winter, when the area is frozen over, as it is largely marshland during the summer. Drilling is done from “islands” in this wetland.

Francis is originally from Colorado. He ended up in Russia via Houston, Texas; Ireland; and the Middle East. He studied geophysical engineering and geology in college and from there he went to work for Texas-based Marathon Oil in the 1970s. They sent him to Ireland, where he worked on the exploration of Kinsale Head, the field that began supplying natural gas to this country.

A stint in Pakistan followed, but he returned to Ireland, where he married. He then headed up Marathon’s operations in Singapore, Perth and Indonesia before transferring back to Houston, where he worked as the multinational’s international production manager. That was in 1989, the year that communism collapsed and the former USSR opened up, sparking immediate interest from international oil companies.

“It was like a land rush,” he says. “All the oil companies were trying to do something in Russia – it was the next big asset that everyone was looking for. So Marathon put me in charge of the task force to see if they wanted to take the company into Russia.”

Marathon ended up winning a tender for the Sakhalin II project on Sakhalin Island, an inhospitable former penal colony between Russia’s east coast and Japan. The field is estimated to have 4.5 billion barrels in reserves and is the latest and most extreme example of frontier exploration. The hazards there include extreme weather, ice floes and even earthquakes.

Marathon and Mitsui were initially involved, and they brought in Shell and Mitsubishi at a later stage, and formed Sakhalin Energy. It is now the world’s biggest integrated oil and gas project. They spent $70 million on a feasibility study, earning the right to negotiate a production sharing agreement, but that contract needed legislation. Once it was passed, Sakhalin Energy put in the first offshore platform.

It took most of the decade, and Francis led Marathon’s efforts through the whole process. “After we proved that you could do a project there successfully, Shell came and bought Marathon out of the project,” he says. “It wasn’t that we didn’t want to work in Russia – it’s just that they made us an offer that we couldn’t refuse.”

Francis hit the road again and began talking to the contacts he had built up in Russia over the previous few years. It was at that point that he came on western Siberia. In the meantime, Russia had reformed its tax and other laws, taking a lot of the risk out of doing business there.

In 2005 he decided the time was right to set up a business to exploit the opportunities in the region, and so Petroneft was born. A private company originally, many of its initial investors were Irish.

For this reason, and because it offered easy access to the capital available in London, Dublin was an ideal fit as a corporate headquarters. So, in 2008, the company listed on the markets in both cities. It’s a little early to say that the rest is history, but it does look like the first chapter is more or less complete.

The company’s focus is to build up both scale and reserves, because once it begins production at a site, reserves decline. “I think, about the fourth quarter next year, we’ll have our production and cash flow right, so we’re very comfortable with where we’re going,” Francis says.

“What we need to do now is to build our well stock. We’ve got nine production wells, so each year from now on we’re going to have to add at least 18. Once you build the well stock, then you are into those years where you’ve got pretty stable production, and you’re not pushed so much to keep adding the wells each year.

“It’s like a furniture store; if you don’t keep restocking the shelves, you’ve got nothing left. And right now we’re depleting the shelves, so you’ve at least got to add each year the amount of wells that you’re producing.”

Starting small in this process gives investors an advantage, because they get leverage. If Petroneft were to add a 20 million barrel field, it would boost reserves by 30 per cent, Francis points out. So does he think that it will add a 20 million barrel field? He laughs: “Next year? I think we’re going to get all of them.”

ON THE RECORD

Who is he?Dennis Francis.

Post: Chief executive of Petroneft Resources.

Why is he in the news?The Dublin-based Russia-focused oil company has just raised €31 million to boost exploration and production in its fields in Tomsk Oblast, Siberia.

Background: A geophysicist and geologist, he spent most of his career with multinational Marathon Oil. He helped to pioneer the development of Sakhalin Island, the world's biggest integrated oil and gas project.

Family: Married with three adult children.

Something that won't surprise:He lives in Houston, Texas, and runs an Irish-based company, the main assets of which are in Russia. He says that he does not have time for hobbies.

Something that will surprise: He likes to spend time fishing.