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New York Times
December 5, 2001
A New Western Focus on Russia, 'Where the Oil Is'

MOSCOW, Dec. 4 -- Joe Mach talks Russian oil in an Oklahoma accent.

After 30 years in the oil industry, most recently spent roaming across Europe and Africa, Mr. Mach (pronounced mack) last year joined Yukos, Russia's second-largest oil producer, as vice president for production and exploration.

His motivation, he said, is straightforward, even if his comparison seems a little fractured. "It's the same reason Bonnie and Clyde robbed banks," he said, sipping coffee from a plastic yellow cup in his spartan fifth-floor downtown Moscow office. "This is where the oil is."

Indeed, for anyone interested in oil, Yukos is now the right place to be. Its fast- growing output is driving a steadily rising flow of Russian oil at a time when the Organization of the Petroleum Exporting Countries, wrestling with a glut, is seeking to curb world oil production and prop up falling prices.

Yukos is not letting OPEC stand in its way. Like several other Russian oil companies, it has attracted Western production experts to help it realize its ambitions to become a major international oil company, planning to increase output by 2005 by about a third, to 1.6 million barrels a day. That would exceed Alaskan production, and is equal to about 8 percent of America's current oil needs.

All this helps explain why Moscow has so far been reluctant to reduce exports by more than a token amount. After rejecting calls to cut output by several hundred thousand barrels a day, Russian government officials and executives from several private oil companies, including Yukos, are to meet here on Wednesday to discuss whether to go along with OPEC's demand for a reduction of Russian exports by 100,000 to 150,000 barrels a day.

But even if the government persuades the companies to support the cutback, setting in motion a larger reduction of as much as 1.5 million barrels a day from the OPEC nations, Russia's growing capacity to produce oil is bound to create further headaches for OPEC in the years ahead.

Behind Russia's renewed strength in the world energy market is a turnaround at Yukos and other companies assembled from chunks of the giant Soviet oil industry. Yukos itself was in a state of collapse when its current owner, Mikhail Khodorkovsky, took it over in 1995.

Soviet planners, bent on getting as much oil out of the ground as fast as possible, had shown little regard for the long-term consequences of their techniques. New fields were pumped full of water to increase their output more quickly and fields were heavily drilled, often to their detriment.

"The whole system was built around an incorrect philosophy," said Jeffrey B. Karfunkle, an American who directs strategic and capital planning at Tyumen Oil, Russia's No. 4 producer. "They had a limited set of tools. They got good at drilling wells. The Soviet attitude was `Let's go — drill more meters!' People got Orders of Lenin for that."

But when the Soviet Union collapsed in 1991, disrupting lines of supply and financing, having so many wells backfired. Existing fields had been pumped too rapidly. Indeed, by the late 1980's, there were few resources for major new exploration or development. The once- mighty Soviet oil industry shrank by more than a third.

Chaos soon engulfed the industry. As the government lost control, managers of oil companies — still all owned by the state — began doing business on the side. Carpetbagging oil traders made fortunes persuading companies to sell oil on the cheap, which they turned around and sold for vast profits at the world commodity price.

"The whole system was coming apart," said Thomas Hendricks, an American from New Mexico, formerly at Exxon, who now works as Tyumen's adviser for drilling. "No one paid for anything. The companies were being gobbled up."

The confusion continued into the mid-1990's, when the Russian government began to privatize the oil companies. The politically connected Mr. Khodorkovsky, now 38, snapped up relatively young fields for a fraction of their value.

Mr. Khodorkovsky, a former banker who does not look like a corporate oil executive in his trademark leather jacket and jeans, threatened outside shareholders with dilution of their equity during a reorganization in 1998. But more recently, he has surprised many by throwing himself fully into the oil business.

Around that time prices collapsed, and owners like Mr. Khodorkovsky finally began to take an interest in production, not just trading. Yukos enlisted help from the Western oil services giant Schlumberger to improve production.

"In effect, all the oil companies at that time, almost all, were hedge funds, not oil companies," Eugene Shvidler, president of Sibneft, another large producer, said. "Now everybody — Yukos, Tyumen, ourselves — are much more involved with the companies themselves, with the mechanics of how they work, not just with cash flow."

Enter Mr. Mach. A former Schlumberger executive, he trained about 1,000 Yukos employees in "production enhancement" — pumping more oil for less money — and installed 500 new computers with software for the task.

"I jumped on that enhancement like a chicken on a June bug," Mr. Mach, 53, said.

The result was powerful and immediate: an 11 percent rise for Yukos in oil output in 2000 from the previous year. None of that, Mr. Mach said, was through new drilling. The company simply changed the way it repaired wells, fixing the best first. It also developed new ways of fracturing — a procedure in which liquid is forced into the rock to increase oil flow. Most industry experts say engineering and well choice are more important than new equipment in increasing output.

For Yukos, much remains ahead. The company owns the northern section of the vast Siberian Priobskoye field, a reservoir with 3.4 billion barrels of oil, about the size of Prudhoe Bay in Alaska. The field, now in its early stages of development, is producing 150,000 barrels a day. In five years, that is expected to rise to several hundred thousand barrels, Mr. Mach said.

Not all Russian companies are as eager as Yukos to increase output. Lukoil, the biggest producer, raised its output last year by only 1 percent. The company has focused on buying refineries and other assets outside Russia. It has the largest reserves in the country, but it also has the highest production costs, according to the United Financial Group (news/quote), a Moscow- based investment bank.

Despite the allure of big untapped fields, foreign companies have been wary about entering Russia. The lack of set tax rules for multibillion- dollar projects has discouraged many from doing business here. Instead, Russian companies have brought in service companies like Schlumberger, which has grown to a staff of about 2,000 employees in Russia from fewer than 500 before 1998, and have poached executives from their ranks.

Still, Russia has changed a lot from the days when owning an oil company was a license to steal. And with several producers determined to expand, Americans like Mr. Mach are increasingly in demand.

"In the next 50 years there are three areas that will be players — deepwater, the Middle East and western Siberia," Mr. Mach said, gesturing to Yukos's production maps that paper one office wall. "It's an oily basin, not slim pickings like Oklahoma."

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