Director General of the Ukraine's only drilling rig manufacturer Discovery Drilling Equipment LLC (Ukraine) Andriy Zagorodnyuk told about the market situation and what awaits Ukrainian producers of oil and gas equipment in future.
Discovery is the only drilling rigs’ manufacturer in Ukraine. Whose was the idea of manufacturing drilling rigs and when did it appear? Why is the plant in Stryi?
The idea appeared in 2005. There were two of us, Mark Flenery and me. Mark previously held the post of vice president in NOV (the world's leading manufacturer of drilling equipment). Mark got us on the international market. It was a pure startup. At first we bought the plant as real estate. The plant itself has been operating since 1885 and produced drilling rigs. At that time it was Austro-Hungary, and out archive dated back to 1906. It is known that it supplied drilling rigs made under Canadian technology to Indonesia, Ethiopia, Spain and Persia. That is, Stryi had a plant with international sales markets. That is, we bought a plant with history. Although in 1967 the plant moved to a new site also in Stryi. In the early 2000s, it was already an outdated post-Soviet plant, which produced noncompetitive by the world standards equipment.
What did you start with? What has changed since then?
At first, we thought that something could be modernized at an old plant, but as a result, we came up with almost nothing. Global standards for drilling equipment were absolutely different from Soviet. This was also the case for both design and engineering, and processes and procedures and requirements for equipment and personnel. Then, at the plant, all the flaws of the Soviet depressive production – theft, alcoholism, neglect of safety equipment, low quality and obsolete technology – blossomed. Its products were of interest only to some Ukrainian customers, of no interest for CIS customers and in general were not perceived in the rest of the world market. With that product, which the plant produced we could not go anywhere.
As a result we changed 90% of staff and threw almost all equipment away. We closed out old procedures and drawings in the archive. Actually we left only the walls. Everything else was built from scratch. Fortunately, then, after the Orange Revolution, there was a rise in optimism about Ukraine and the American venture fund came to our startup.
When we came to this factory in 2005 and still had no investors, no new team, we said that in a couple of years it will produce products that will be supplied to developed countries and will drill the wells for world leading companies, such as Shell and BP. In the beginning we were ridiculed, they said it is a utopia. Nobody believed that this was possible in Ukraine at all, and especially in such production. However, in two years we have supplied products to contractor-companies BP and Chevron. In particular, already in 2007, our rigs drilled at the Chevron sites in Poland. The rig was built according to API standards. A year later, we already built the rigs that are currently drilling for BP and Shell and other most demanding companies. Everything turns out to be possible if you really want it.
Now that foreign engineers and instructors come to us, they find themselves in the environment where the vocabulary, terminology, processes and procedures are that adopted in foreign countries. All of this was brought to the attention of the Western specialists. For instance, in 2008 the factory employed 45 foreign experts. The quality system was adjusted by a specialist who in particular was a member of the API board, but the person who implemented this system was from Ukraine, from Kyiv. All the rest was done by foreigners, including welding, preparation, production placement, lean manufacturing system which was also introduced, procurement, inventory system, etc. At present, only one foreigner works at the plant, and everything else is done by our specialists. In addition, we have one engineer in Houston and one engineer in the United Kingdom. They work on innovation and in particular new drilling technologies.
What was the investment into the plant during its existence? Who were the investors?
The initial investment was USD 15 million invested by the venture fund directly into the plant, engineering. Further on we were re-investing.
What are the main works that are currently performed at the plant?
The plant produces metal, precise mechanical equipment and performs all engineering works. And also the final assembling. The engineering part will soon move to Lviv, because Stryi already lacks staff (they it’s a long story and there are not enough those who are ready to commute to Stryi more than an hour each day). This decision has been maturing for a long time. In general, the main asset that we were able to create during our history – is an engineering base, technology and processes at the plant because there is no special unique equipment there.
We also had more than 10 projects in which we assembled the in the territory of the customer. We realized that there was such a narrow niche, and due to this we were ahead of our competitors. That means there is no need to bring all equipment to Ukraine, and then bring everything assembled to the customer on the other end of the world. It is possible to transport it to the customer's country immediately and there assemble a drilling rig.
In particular, we assembled rigs in Poland, Nigeria, Indonesia, Russia, Kuwait, Oman, Saudi Arabia, Kazakhstan, Colombia, etc. Due to this we save on logistics. For example, if you ship a drilling rig from Ukraine to the United States (or vice versa) it will cost $ 1 million.
What is the price policy of a company? Who are your competitors? Can you compare the cost of Discovery drilling rigs with those of other manufacturers?
Our competitors are all drilling rig manufacturers, minor and major. Generally in the world there are three large groups of manufacturers. First, European and American manufacturers, second – Chinese, third are the producers from the former Soviet Union, working mainly on their home market. We work in the European-American market and compete with them. But we are cheaper than they are. For example, foreign manufacturers build standard rigs, and if they produce customized rigs it is already very expensive. We create custom built machines at competitive prices.
As far as Chinese manufacturers are concerned, they produce very different quality products. So, a Chinese drilling rig could be half the price of an American or European counterpart, but the cost of ownership (TCO – total cost of ownership) of the Chinese drilling rig may be significantly higher over time. The American drilling rig will work well for many years, while the Chinese are usually cheaper, lower quality, more likely to fail and more expensive in service. You can make an analogy with cars.
Are there any Discovery production issues?
The main issue is a powerful trend for the migration of workers to Poland, and then further into European countries. On the one hand, this is good, because when people work in the West, there is an understanding of many processes, quality, and safety (for example, why you should wear hardhat, be responsible for quality, etc.) But the problem is that people leave and do not come back. Many work by shifts, six months in very difficult conditions, and then return for the winter period and rest.
It is difficult for us to compete, although we do not stop paying salaries, but people are still leaving. We currently have signed the agreements with four colleges (vocational) on practical training for welders and plumbers under the American standards directly at the plant and actually create a new school of welding. With us, these young specialists can get experience and qualifications according to world standards and work anywhere after some time.
Are there any issues with government agencies?
Earlier, in the days of Yanukovych, we had huge issues with the state. Tax inspection imposed heavy fines on no grounds. We wanted to agree with them, paid bribes, we were absolutely opposed. Then there was Maidan and we had a lot of people who went there. Now all charges are lifted and nobody touches us, even help as much as they can.
I must say that there are other issues, but not with state authorities but rather with the lack of public policies to support production. The development of the production is related to investment in technical upgrade. This is a continuous process. A process that requires constant investment. In Ukraine it is very complicated both with financing and taxation of investments. Abroad there are powerful loan programs for replacing the means of production, operational leasing. For example, you come to Siemens or General Electric and they offer you financing options, including various types of leasing. We do everything at our own expense. And this actually restrains the entire industry in Ukraine.
What is happening today in the drilling and drilling equipment market in the world?
For onshore drilling there is one living region – the Middle East. There are only a couple of dozens of contractors working. It develops and will be developing. In addition, there is United States with shale hydrocarbons. But they are not currently buying new drilling equipment. Now there is the recovery period of former capacities that have been idle for several years. Most of the small companies in the US and Canada, with whom we started in 2006, have long gone bankrupt. In Canada, almost all independent drilling equipment manufacturers have shut down or changed the work profile. Somebody was able to re-profile, but most of them closed. In fact, the Canadian market is not stagnant, but simply dead. The Chinese, however, are working very actively. Europe works, and in particular the German Bentec, with which we have partner relations.
How do you assess the state of the Ukrainian market of drilling rigs?
We have Ukrgasvydobuvannya and all the rest. Ukrgasvydobuvannya is in a surge and this event is seen in general world market. Last year Ukrgasvydobuvannya was the largest buyer of drilling equipment among all companies in the world – 20 drilling rigs. But I do not know yet how will the situation develop further, because it depends on future company policy for the period after 2020.
If we talk about other companies in Ukraine the market will exist and develop. The market will be filled with the used equipment and it will compete with new. The development of markets is still tied to the overall economic situation and the investment attractiveness of oil and gas production. If small mining companies come to Ukraine then the service market will grow, if not, then no.
From Ukraine after the war started practically all major oil and gas players left. The beginning of the war – was a very convenient occasion to go, although it coincided with the sharp drop in oil prices. And as far as I know, so far they are not going to return. On the other hand, proper conditions have been created in Ukraine: the corruption scale in the industry has gone down, the taxes on production were reduced, and we have a gas market. But still in the West we are perceived as a high-risk area. The Western press writes mostly negative about Ukraine, about the slow movement of reforms and corruption. This is very restrictive for investors.
How do you rate the program for drilling equipment upgrade in Ukrgasvydobuvannya?
The program is very ambitious and very good that it is there. In addition, Ukraine's transition to world technical standards is very positive and in the historical perspective it will be of great strategic importance.
We also participate in the Ukrgasvydobuvannya’s program. We make certain equipment that will be installed on future Ukrgasvydobuvannya’s rigs. The first deliveries of drilling rigs will start September 2018, and then every two to three months there will be the next one.
How do you rate the possibility of a deep upgrade of Uralmash rigs, which are many in Ukraine?
Modernization can be carried out; such international practice also exists. In some cases, upgrading is a more promising market than new equipment, as companies often have been partially replacing equipment for years.
According to the international unwritten practice, a new unit is considered a new one if it has a new derrick and travelling block. Depending on the equipment, it is 20-25% of the cost. Very few companies can afford capital investments in the purchase of new rigs, and more and more companies are on the way to their modernization and the gradual replacement of equipment as it goes out of service or out of date. And this tendency will be preserved for a long time. Some companies have many rigs made in the 80's. There are many such in the Middle East. If you look at them closer, it is evident that since the 80's only a mast and a foundation remained, and everything else was changed. And then the mast and the foundation will be changed (winch and doghouse) and it will suddenly become new. Because the rig is not a car, it's like LEGO.
But this is all the rigs that have been made according to the API standard. In Soviet rigs, everything is much more complicated. They change the winch, the entire circulation system and convert it to an electric drive. Effectiveness of the rig increases, but it's still not the same as in the modern API rig.
In a situation where there is no money (or they have been spent to the purchase of equipment as in UGV), upgrading can be a way out, but only if there is a program to "replace everything" in the end. This replacement may take 10 years depending on the number of the rigs.
Ukrgasvydobuvannya left many old rigs. Slowly they will be the modernized, and sooner or later, it will receive new old rigs. It is technically possible.
What is the prospect of mastering equipment for the offshore development?
We participated in the development of marine projects. For example, we produced one rig for Chornomornaftogaz. This was in 2013. A small rig with a carrying capacity of about 150 tons, which could drill, and perform CWO, and it could be removed and transferred onshore. Absolutely unique and individual design, fully compliant with Western standards and API certified. It, unfortunately, remained in the Crimea. We were offered to maintain it, but we surely refused. We do not know what is happening to it now. We also did a project in Indonesia. There we made a huge 1000-ton rig on a barge for shallow drilling and its rig-up.
Conditionally, offshore drilling platforms consist of two large parts. The first is an add-on – a drilling part that is about 20% of the cost of a floating drilling platform. The second part – the platform itself, which is respectively 80% of the cost. The second part is no longer the oil and gas engineering industry, but the machine building and ship building industry which is mainly performed on shipyards in Singapore, Korea, China, and also traditionally in Scotland, Texas, Louisiana and so on.
As for the production of such equipment in Ukraine, I think it is possible to do this, but subject to the market and economic feasibility. Creating production for one such platform makes no sense. And to build an add-on drilling rig is no issue at all. There is a huge number of unencumbered drilling platforms in the world, so it is logical to buy them, restore and work. Most likely is not meaningful to do from scratch.
In addition to the Bentec project for 5 drilling rigs for Ukrgasvydobuvannya, what else does Discovery manufacture today?
A new heavy rig will appear in Ukraine shortly. We finish the rig for Ukrburservice with a carrying capacity of 450 ton. At the moment it is waiting for the assembly. The yard works were completed late last year. We recently completed a drilling rig modernization project that we have been executing during previous years and the rig is currently operating in Kuwait. We have made a super-complex vertical moving system for drilling 550-ton rigs: platform on wheels for rapid drilling rig moves. Manufacturers of huge, up to 3.5 meters in diameter wheels, were found in Ukraine, in the Dnieper. The customer was very satisfied with our work, as always.
What do you think needs to be changed in order to allow machine building in Ukraine developing?
It is worth noting that Ukraine as a state needs urgent measures to support machine building. All countries in the world support their producers, except Ukraine. In some cases, even over-support. For example, the Chinese are often dumping in the market, because the state compensates them for a lot of things, in particular, the cost of delivery.
In Ukraine, a paradoxical situation often develops. For example, if you bid in a tender as a Ukrainian company, you enter into contracts in UAH, and you take loans in hryvnia, which are other currency risks and rate, which is unacceptable for normal machine-building products where there is a large imported component. If you are a foreign company, you work in a currency. Similarly, when supplying to the domestic market, Ukrainian companies include VAT, which they have to finance independently. Here is an example of actual unplanned discrimination of domestic companies.
Export support is a separate situation. In other countries, say in the US, Germany there are export banks that support their producers. They provide loans for re-equipment of production facilities by new automated equipment, loans for works, letters of credit and bank guarantees, as well as guarantees for participation in tenders (bid bonds) and performance of works under the won tenders (performance bond). If in our country urgent measures are not taken to support the Ukrainian machine builders, we will witness the disappearance of the whole industry, and this is not only oil and gas engineering. We also see that competitive production is easier to develop in the world markets than at home. For example, it would be much easier for us, for example, to engage in manufacturing in the Middle East where there is a permanent market, including a market of cheap capital.
Although, in any case, engineering will remain in Ukraine, which, in my opinion, can save Ukraine because we have highly qualified engineers and this is an asset that has huge potential.
Another very impressive and at the same time an interesting trend is the active use of robots in production. A fully automated welding machine in China costs $20,000. You download the drawing, and it welds. The quality is perfect and payback is only a couple of years. The speed of the development of robotics and automation of production, may be as rapid as transition to mobile phones from stationary. As a result, we will all be witnesses to the process of production reshoring (the process opposite to transfer of production to countries with cheap labor resources, offshoring). For example, machine-building plants from China will return to the US and Europe will appear in the Middle East, as they will save on logistics and win due to proximity to the consumer.
Ukraine only needs to establish an adequate state policy in this area. In the country there are wonderful specialists and people. There is no need for any irreversible subsidies, there is no need for localization or limitation of competition; just an adequate policy is needed, similar to the policies of European countries, which would support investment and exports. But there are currently no such trends. If they do not arise in the next couple of years, we can see irreversible processes in the whole industry. At the same time, we, as a company, used to survive under all conditions, and we do not ask for anything. We will survive under any conditions with any public policy. However, it is not a fact that in this case, in a few years, this will still be Ukrainian machine building.