RUSSIA - Part 4 - External Investments Increase; LUKoil Becomes Trans-National.

External investments by the privatised Russian petroleum companies have become an important reality. Rich in cash thanks to high oil prices since April 1999 and aggressive in their pursuits, the integrated companies are moving primarily into East Europe where downstream assets are cheaper and more manageable for the Russians than those in the West. But the bigger Russian firms have moved to the West already.

With the Russian companies' emphasis in East Europe being on downstream assets and marketing, their priority for acquisition of upstream assets is the Caspian region and Central Asia. Iraq and other parts of the Near East that will eventually be accessible to Russian firms will be a priority for acquisition of upstream assets in view of this region's vast petroleum reserves. But it has to be borne in mind that Russia itself is the biggest petroleum reservoir in the world, with its oil and gas reserves being more than 15% larger than those of Saudi Arabia.

Communist Russia's old geo-strategic control over East Europe and Central Asia is gradually being replaced by business interests from a capitalist Russia, a country stretching to the Far East.

Meeting in St Petersburg, the Group of Eight (G8) summit leaders on July 16 pledged to promote "open, transparent" energy markets and to develop nuclear power as an alternative source for those who want it. The G8 powers, this year chaired by Russia, recognised several key ideas for the functioning of global energy markets, including the principle that they be "open, transparent, efficient and competitive". The leaders' statement said: "Energy is essential to improving the quality of life and opportunities in developed and developing nations. Ensuring sufficient, reliable and environmentally responsible supplies of energy at prices reflecting market fundamentals is a challenge for our countries and for making as a whole".

The G8 leaders expressed support in principle for the European Energy Charter (EEC), a framework of rules which Russia has so far refused to sign despite increasing admonitions to do so from the European Union (EU). The leaders said: "We support the principles of the Energy Charter and the efforts to participating countries to improve international energy cooperation". Their statement on energy was accompanied by a detailed action plan focusing on seven main areas including promotion of energy market transparency, stability and predictability and making investment easier. They adopted separate declarations on several other topics on the agenda including education and infectious diseases, as well as fighting corruption and protecting intellectual property.

The powers acknowledged the need for the world to diversify its sources of energy supply through greater emphasis on renewable energies including safe nuclear energy for countries wishing to have it. The statement said: "We recognize that G8 members pursue different ways to achieve energy security and climate protection goals. Those of us who have or are considering plans relating to the use and/or development of safe and secure nuclear energy believe that its development will contribute to global energy security".

Most of the G8 powers have been placing increasing stress on development of nuclear energy as a necessary alternative to fossil fuels, though Germany plans to phase out nuclear power and has opposed this. The leaders signed off on an action plan to step up the fight against global warming and to recognise that it was closely linked to governments' energy policies.

Internal Acquisitions Vs Kremlin Moves: The Russian companies' branching out of their country since April 1999 - apart from external acquisitions they had made since 1993/94 (see review of the companies' external assets on the following pages) - was occasioned by these important developments:

In March 1999 they began to count on OPEC's defence of crude oil prices. Until late 2001, most of them went along with Moscow's active support of the OPEC price defence efforts through occasional Russian oil export cuts in line with agreements involving non-OPEC states. Until March 1999, when OPEC and four non-OPEC states including Russia agreed to cut output to defend a crude oil price that had collapsed in 1998, the Russian oil firms favoured Moscow's export cuts. That was because in 1998 Russia had suffered its worst financial crisis since the late 1991 collapse of the Soviet Union. For all the Russian petroleum companies, including the world's biggest gas producer and exporter Gazprom, a strong oil price and a brighter market perspective for both oil and gas were crucial for their growth.

By late 2001, however, the situation in Russia had changed. There had developed a split in strategic thinking among the integrated oil companies in Russia. The split was between the so-called radical firms, which had managed to increase oil production and lower operating costs rapidly as in the case of Yukos and Sibneft, and the conservatives like LUKoil and SurgutNefteGaz (SNG) which had opted against the oil production methods of the radicals (see profiles of the Russian oil and gas producers in OMT, DT and Gas Market Trends No. 8).

The radicals by late 2001 had opted for acquisition of smaller firms in Russia. That was because assets to be acquired were still relatively cheap despite high oil prices. Yukos, Sibneft and Tyumen Oil (TNK) were prominent among those which grew out of such acquisitions (see background in Vol. 59, No. 13). In 2003, the Russian assets of TNK and BP were merged into one group, TNK-BP. A much bigger merger, between Yukos and Sibneft to create a much bigger group was halted as the Kremlin moved against the owners of Yukos. By then, Yukos had been leading Russian firms opposed to Moscow's co-operation with OPEC in defending oil prices from the beginning of 2002. Since end-2001, Yukos and the other radicals had become in better shape to operate under a low oil price environment, whereas companies like LUKoil and SNG had failed to cope with such a situation. Yukos had become the biggest among the Russian oil firms in terms of market capitalisation and had begun to raise oil production capacity at top speed.

By Oct. 25, 2003, when the company's founder and CEO Mikhail Khodorkovsky was arrested, Yukos had become the biggest oil producer in Russia. But President Putin's Kremlin, while still eager to see oil prices high, was no longer keen on being too closely associated with OPEC price defence efforts. The Kremlin now was more eager to raise taxes on Russia's oil majors to a level that should channel much of their cash piles to the state. It was payback time; they had bought their assets from the state at ridiculously low prices. This new drive began with Yukos, which went bankrupt on Aug. 1, 2006 (see the background & external assets of Yukos in Vol. 63, Oil Market Trends No. 10 - omt10cRusOverseas-04).

Immediately after the bankruptcy was declared, Russia's state-controlled companies Gazprom and Rosneft led the fight to acquire both the local and external assets of Yukos. In mid-August a Dutch court threw out a bid by the Yukos liquidator, Eduard Rebgun, to take control of the foreign-held assets held by Dutch-registered Yukos Finance.

On Aug. 11, Yukos shareholders voted to dismiss Yukos Finance's chief financial officer Bruce Misamore and chief lawyer David Godfrey. That was at a special meeting convened by Rebgun. According to Petroleum Argus of Aug. 21, Rebgun said "the two men did not inform him about sales of [Yukos] foreign assets", including a 53.7% stake in Lithuanian oil company Mazeikiu Nafta (MN) and a 49% share in Slovak Pipeline operator Transpetrol.

MN, which has a major oil refinery, a terminal and a network of petrol stations in the Baltic state, was eventually taken over by PKN Orlen of Poland. LUKoil, the biggest oil company in Russia since the demise of Yukos, had been among the most serious bidders for MN. The other bidders for MN included TNK-BP.

In the meantime, However, Russian crude oil supplies to MN's refinery were cut off after an oil spill at end-July. Russia's state-owned oil pipeline monopoly Transneft has since been vague about the causes of the cut. Argus on Aug. 21 said: "Many observers remain convinced that Russia is using the issue to put pressure on the...sale of MN to Polish firm PKN Orlen, although Transneft denies this" (see the background in omt9RusExprt-Aug28-06).

Damage at the crude oil pipeline to MN's Butinge terminal has not been properly explained by Transneft. Argus quoted Transneft Vice President Sergei Grigoryev as saying: "We are considering several options" [to repair the pipeline]". But Argus said he did not confirm remarks attributed to Transneft President Semyon Vainshtok to the effect that "the pipeline serving MN may have to close because it is over 40 years old".

GazpromNeft, a unit of Russia's biggest company Gazprom formed to run Sibneft which the latter acquired in October 2005 for more than $13 bn, in July 2006 offered to pay $105m for Yukos' 49% stake in Transpetrol. Gazprom, Russia's biggest holder of external assets (see Gas Market Trends), had also staked a claim to Yukos' 20% share of GazpromNeft. Yukos valued this equity at $4.2 bn, whereas Gazprom offered "over $2.5 bn" according to Argus.

Argus on July 31 said: "Even if Yukos' remaining assets are sold through an ostensibly open auction, state-run [Russian] firms are expected to take the most attractive spoils. Foreign companies are likely to have little chance".

Yukos' key upstream assets include these two crude oil producing units: TomskNeft (223,000 b/d) and SamaraNefteGaz (185,000 b/d). Argus said Gazprom had expressed interest in TomskNeft, as well as in East Siberian Oil & Gas which holds the licence to the Yurubcheno-Takhomskaya field in east Siberia with estimated reserves of 1.73 bn barrels of oil and 480 BCM of gas. Argus said other Yukos assets in which Gazprom was interested included ArktikGaz, Yukos' only gas-produc-ing unit, and its 384,000 b/d Angarsk refinery in east Siberia.

In his capacity as "external administrator" of the stricken company, Rebgun on July 25 put the value of Yukos' remaining assets at $17.7 bn, while the firm's liabilities were estimated at $18.3 bn. But Yukos claimed its assets were worth $37.7 bn and said it could pay all legitimate claims against it.