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The Stealth Oil Giant


Why Schlumberger, long a hired gun in oil-field services, is becoming a major force and scaring Big Oil

Pad 1b Lempyskoye is a pretty desolate spot. The drilling site for Russian oil giant Rosneft isn't much more than a snow-covered clearing in the endless evergreen-and-birch forest 1,200 miles northeast of Moscow. Its 37 staffers live in spartan trailers, and the lavatory is a rank hole in the ground beneath a metal shack. In the winter, temperatures drop to 40F or lower, and in the spring the whole area thaws into a mosquito-infested swamp. As a drilling rig bores well after well deep into the frozen Siberian earth, it is wrapped in green tarpaulin to protect workers from the wind and cold.

Little indicates that oil services provider Schlumberger (SLB), a multinational giant with headquarters in Paris and Houston, is in charge of drilling at Pad 1b. Nearly everyone wears the green jacket and overalls of the Schlumberger subsidiary in Russia that runs the rig, and there are no signs to indicate the foreign company's role in the project. When a board member recently floated the idea of rebranding the Russian operations as Schlumberger, the local team rejected the proposal. "I don't see what we would gain," says Maurice Dijols, president of Schlumberger Russia. "We need to keep the Russian identity."

Schlumberger has gone native in Russia. It has a global reputation as a leader in oil-field services, but its thriving Russian business has been built on three local outfits it has bought since 2004. In each case, Schlumberger revamped operations but kept enough of the old company intact to preserve its earthy Russian character. Schlumberger "doesn't make the assumption that the West is best," says Rob Whalley, a sturdy Briton who serves as the company's drilling czar in the country.

It helps to keep a low profile. Schlumberger has prospered by offering its services through local subsidiaries, even as Moscow has strong-armed Royal Dutch Shell (RDS) and BP (BP) out of premier assets, forcing them to hand over control of big fields in Siberia and on Sakhalin Island to state-owned Gazprom, now a Schlumberger client. Schlumberger has 14,000 employees in Russia, and its revenues there topped $1.5 billion last year, triple the level in 2004. "Russia could one day be as big for us as the U.S.," where Schlumberger gets nearly 30% of its revenues, says Chief Executive Andrew F. Gould, a British native who has lived in Paris for decades.

You could call Schlumberger the stealth oil major. Sure, giants such as ExxonMobil (XOM), Chevron (CVX), and BP dominate headlines in the global quest for crude. But they couldn't do it without Schlumberger. The company helps them scope out pockets of oil thousands of feet below the earth's surface, conjuring up their layer-cake images on a computer screen, and then threading drill bits through the richest bands.

Schlumberger has figured out better than anyone else how the global oil game has changed, and it's helping to drive that change. The company is increasing its cooperation with Big Oil's most prominent rivals, state-owned oil companies, and it's helping a group of smaller upstarts that are seeking to get into the business, such as hedge funds and private equity outfits. Just outside a suburban neighborhood near Dallas, for instance, it has drilled a half-dozen gas wells financed by New York hedge fund Och-Ziff. While the majors typically want to own rights to oil reserves in the fields they operate—and take a share of the profits—Schlumberger has long been happy to work on a contract basis, getting paid a fixed fee for its services. "Schlumberger is the indispensable company," says J. Robinson West, chairman of PFC Energy, a Washington consulting firm. "They are involved in every major project in every important producing country."

Since taking the top job in 2003, Gould has refocused the company on its core oil-services business. The 61-year-old CEO's biggest efforts have been in Russia, the Middle East, and other key oil-producing regions, where he has won high-powered friends by building training facilities and research labs. Schlumberger's tentacles today stretch from drilling rigs in the scrublands of central Mexico to a 65,000 sq.-ft. research center in Dhahran, Saudi Arabia, to a dreary Soviet-era office complex in Siberia. In each case, Schlumberger's far-flung operations help solidify relationships that threaten Big Oil's dominance of the business.

As fields such as Alaska's North Slope and the North Sea have been depleted, the international giants have turned to the developing world for new supplies. But governments of the biggest producing countries haven't exactly embraced the majors. Instead, they want the choicest reserves to be controlled by their national companies, which have turned to service providers such as Schlumberger, Halliburton (HAL), and Baker Hughes (BHI) for the latest Western oil-field technologies.

Flush with profits from record prices for crude, the state-owned outfits no longer need the capital of the majors. These national companies—Saudi Aramco, Mexico's Petróleos Mexicanos (Pemex), Gazprom and Rosneft from Russia, and a dozen or so others across the globe—control more than four-fifths of known reserves. They don't want a Western oil company telling them how to do things or taking a fat chunk of the profits.

Schlumberger appeals to the state-owned players because it's a company without a country: It's registered in the Netherlands Antilles, but Gould is based in Paris, and the company maintains large offices in Houston and London. Since 2000, Schlumberger's sales to national oil companies have grown twice as fast as those to the majors. By 2006, sales to the nationals hit $5 billion, just ahead of revenues from the big international players, the company says.

At the same time, Big Oil has lost its lock on the knowhow needed to manage complex projects. While the majors still lead in this area, Schlumberger is closing the gap. And the company has pulled ahead in technology. As oil prices tumbled to just over $10 per barrel in the late 1990s, the multinationals cut back on research and development. Schlumberger, by contrast, has always considered itself a technology company, so it kept up its spending, devising new and more efficient ways of detecting and extracting oil and gas. Today the majors invest less than 1% of revenues in research, while Schlumberger spends about 3%, or some $700 million this year.

INDISPENSABLE PLAYER

Schlumberger was founded in 1926 by two science-minded French brothers, Conrad and Marcel Schlumberger. They figured out how to use electric currents to locate oil hidden in the rocks deep underground. Now, Schlumberger helps oil companies guide drill bits through twisted paths miles beneath the earth's surface. It's a top player in seismic imaging—mapping the subsurface using sound waves—and is the world leader in well logging, or lowering an instrument packed with sensors down a well to determine the rock structure along the drill hole. "It would be very hard to do without Schlumberger," says Sadad Husseini, a former executive vice-president at Saudi Aramco, the kingdom's national company. "Schlumberger has been critical for Saudi oil-field development."

Schlumberger's strategy seems to work. Its operating earnings are likely to approach $7 billion for 2007, up 38%, on sales of $23 billion, a 21% increase, according to research house Sanford C. Bernstein & Co. (MMC) By contrast, Schlumberger's nearest rival, Halliburton, is growing more slowly and is likely to see operating profits of $3.5 billion on sales of $15 billion, Bernstein reports. Despite a 10% drop in its share price since October, Schlumberger's market capitalization on the New York Stock Exchange is a hefty $120 billion, making it No. 25 in the Standard & Poor's 500-stock index, just behind Coca-Cola (KO) and PepsiCo (PEP), and ahead of Wal-Mart (WMT) and McDonald's (MCD).

Now, Schlumberger is fast building up a new business that strays from its traditional role as a service provider and moves deeper into areas once dominated by the majors. The company's Integrated Project Management (IPM) unit is based in a low-rise building surrounded by lush gardens a short walk from London's Gatwick Airport. IPM aims to do just about anything an oil-field owner would want, including management of drilling programs and production. "What you see is more and more people who don't have technical knowledge buying into oil fields," says Gould. IPM's revenues almost quintupled, to some $1.6 billion, between 1999 and 2007, and the unit now has an order backlog of $4.8 billion.

The group is also challenging Big Oil by helping national companies gain a foothold away from their home turf. Russia's Rosneft, for instance, won exploration acreage in Algeria but had little experience in the country. Thanks to decades of working there, Schlumberger was able to round up a drilling rig—a scarce commodity in Algeria—from a subsidiary of Sonatrach, the national company. Schlumberger built an airstrip in a remote region, drilled two exploratory wells, and found gas for Rosneft.

HIRED GUN

Like the majors, IPM is willing to assume more risk to reap greater rewards, but without taking an actual stake in oil reserves. While the bulk of Schlumberger's work is done for fixed fees, in 2003 IPM worked out a profit-sharing arrangement with Shell and Petronas, Malaysia's national oil company. Schlumberger agreed to redevelop and manage Bokor, a Malaysian field where output was falling. It boosted production by 40% and got a share of the increase for its trouble. Schlumberger has a similar partnership with Romania's Romgaz at the Laslau Mare field in Transylvania. Such deals now account for about a quarter of IPM's revenues, and that figure is likely to rise, says IPM chief Miguel Gallucio.

Some of IPM's biggest contracts are in Mexico. Schlumberger's relationship with domestic monopoly Pemex goes back to 1938, when Mexico nationalized foreign oil interests and Schlumberger helped the Mexicans weather a subsequent embargo. Mexico's constitution bars outsiders from owning oil reserves, which has benefited Schlumberger since it's willing to work as a hired gun. Over the past five years, IPM crews have drilled at least 1,000 wells in the Burgos Basin south of Brownsville, Tex. This vast field has helped reduce Mexico's dependency on imported natural gas—and led to another, $1.4 billion, contract for Schlumberger in the Chicontepec field in Veracruz and Puebla states. Schlumberger assumes wide responsibility on such projects, including tedious steps such as obtaining permits from local authorities and environmental agencies. Schlumberger "has been utterly successful at penetrating Pemex," says George Baker, a Houston consultant who follows Mexico's oil business.

As Schlumberger reshapes the industry through its work with the nationals, it's setting up a potential confrontation with Big Oil. "At some point we are going to have to have a conversation," says an executive at a major European oil company. "Are they taking business away from us by making the national oil companies not need us?" The majors still give Schlumberger billions of dollars of business annually, and engineers around the world train with course materials developed by Schlumberger and use the company's software. But they're not going to be happy if Schlumberger helps the nationals cut out the likes of ExxonMobil or BP. Christophe de Margerie, CEO of French giant Total (TOT), says he meets Gould a few times a year and regularly warns the Schlumberger boss not to stray too far onto his clients' turf. Gould counters that Schlumberger doesn't compete with the majors, since it's not interested in owning reserves. "We offer all of our customers the same service," he says. "There is no distinction in our minds between" the Western majors and the national oil companies.

Gould, a 32-year Schlumberger veteran, took an unusual course to the top of the engineering-driven company. He started in the Paris office as an accountant rather than in the engineering programs most Schlumberger recruits are put through. After 15 years in finance, he switched to management (on an offshore drilling unit at first) and then moved up the ranks, eventually sitting through much of the basic training in well logging. "I had to do a lot of late-life learning about technology," he says.

Gould largely eschews the perks typically granted to top executives of big multinationals. He usually flies commercial. And Nader Sultan, a former CEO of Kuwait Petroleum, tells of finding Gould staying in an $80-a-night hotel in Cambridge, Mass. The Schlumberger chief explained that he liked the location next door to the company's research center. "You can have a good dialogue with Andrew," says Sultan. "He is very open."

Gould has clearly been open to shedding businesses that don't fit his vision of the company. Early in his tenure as CEO, he sold off several computer technology businesses that Schlumberger bought in an effort to diversify. Investors wanted Schlumberger to stick to what it knew best: oil-field services. And Gould says Schlumberger's engineering corps saw the diversification as a sign that management believed the oil industry's days were numbered—which he felt would ultimately hurt the company's service. "There was so much bad publicity [about diversification] that it was undermining the morale of the oil-field employees," he says.

After selling the IT investments, Gould put more chips on places he thought were crucial to the future. The company has added 25,000 employees, a 50% increase, on Gould's watch, most of them from developing countries. He closed a research facility in Ridgefield, Conn., and opened a spanking-new glass-fronted research center on the campus of the King Fahd University of Petroleum & Minerals in the heart of Saudi Arabia's oil-rich Eastern Province. He recently inaugurated a training center in Abu Dhabi and has opened various facilities in Russia.

AIRPORT HEADQUARTERS

Such investments help burnish Schlumberger's image in host countries. In Saudi Arabia, for instance, Schlumberger is at the heart of the kingdom's $24 billion plan to boost production capacity by 25%. It operates some 70 drilling rigs in a joint venture with Saudi investors and did much of the drilling and other work at the 16 billion-barrel Shaybah field the Saudis developed in the 1990s. And while the handsome neoclassical building on the King Fahd campus is clearly meant to be a token of Schlumberger's commitment to the kingdom, Schlumberger is also likely to profit from its location near the country's giant oil fields. The crude there sits in limestone, which is poorly understood compared with the sandstone that prevails in the West. The center's researchers are busy working on the best ways to extract oil in those areas.

Gould's push in Russia could turn out to be his boldest stroke of all. Russia's oil-services market was worth some $13 billion last year, and it's growing at a pace well into the double digits. These days, the business-class lounge at Moscow's Domodedovo airport has become the unofficial headquarters for Schlumberger executives and engineers boarding Soviet-era Antonov and Tupolev jets for the long flight out to West Siberia, which accounts for about four-fifths of Russian oil production. The region requires thousands of new wells, such as those being drilled at Pad 1b Lempyskoye, just to keep output at current levels. And there's still lots of oil to be found. In the 1960s and '70s, Soviet drillers moved rapidly across the forest and tundra, hitting big pockets of oil but bypassing the smaller pools. These can now be tapped by the tricky horizontal wells Schlumberger has taught its Russian employees to drill, and production at old wells can be bumped up by a process called hydraulic fracturing, another Schlumberger specialty.

Schlumberger was a big player in Russia at the dawn of the oil industry in the 20th century, but it got the boot after Stalin came to power. Then, in the late 1990s, it formed an alliance with Yukos, at the time Russia's biggest private oil company, eventually dispatching 300 workers there and helping to kick-start flagging production. Schlumberger forged a similar deal with another massive private player, Sibneft. But as Yukos' owner Mikhail B. Khodorkovsky fell out of favor with the Kremlin, Russia chief Dijols knew he needed a far wider client base.

His solution: buy local services companies and bring their work up to Schlumberger's standards. Although Schlumberger is considered to have the best high technology in the industry, it lacked certain midrange skills. More important, the deals brought contacts and understanding of the Russian business landscape. Schlumberger's handling of Siberian Geophysical, which operates Pad 1b, is typical of its approach. Although Dijols says Siberian was in terrible shape when Schlumberger bought it from Yukos in 2004, the dozen Schlumberger executives parachuted into the company did little but observe for about a year. "It is like West Texas," Dijols says. "Everything is based on personal relations. People are very proud. You can't come and say, We will give you a lesson.'"

The company is gradually changing its old Soviet culture of blame. Luc Ollivier, a 50-year-old Frenchman, was installed as the boss of regional operations at Siberian Geophysical. He's trying to reward performance and, more critical, systematically eliminate mistakes rather than simply punish the people who make them. Ollivier says the company's veteran drillers have immense experience, "but they don't like to teach the young people." So he is working to forge better ties through daylong get-togethers that conclude with a beer bash. Ollivier says the pace of work is up by more than 30% in the past two years, and Siberian Geophysical's drilling revenues reached about $250 mi


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