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RUSSIA - LUKoil.

The largest oil group in Russia if Yukos goes bankrupt, LUKoil produces over 1.7m b/d. It prefers to remain conservative. By July it had become second to ExxonMobil among the world's non-state owned oil groups in terms of proven reserves. According to an audit done in 2003 by the respected US consultant Miller & Lents, the group's proven reserves at end-2003 stood at 20.1 bn barrels of oil equivalent. LUKoil says it compares favourably with other Russian oil companies in terms of reserves replacement. In 2003, it replaced 195% of the oil it produced through oil exploration as well as acquisitions and revision of earlier estimates.

LUKoil Vice President Leonid Fedoun in April 2002 told The Financial Times: "We believe we should increase production in new fields because producing more in west Siberia involves extracting eight tons of water for every ton of oil". He said the "radical" methods applied by SibNeft and Yukos were causing long-term damage to their fields "by boosting the intensity of exploration of fields with a high degree of water content". LUKoil has been proven right as the number of water barrels coming out of each barrel of oil in west Siberia has increased at an alarming rate.

Unlike Khodorkovsky who became a "billionaire overnight" in the 1990s and bragged about his ambitions to rival President Putin, LUKoil founder and CEO Wagit Alekperov is an Azeri-born aparachik who has been extremely cautious and has never challenged the Kremlin or made political statements not in line with official Russian state policy. Whereas Khodorkovsky belonged to the category of capitalist billionaires among the "New Russians", Alekperov is known as a "red billionaire" who shuns publicity and never appears to be ostentatious (see who's who in Part 5).

LUKoil was structured in 1992. Its name derived from three production associations in west Siberia that were merged: LangepasNefteGaz (then with capacity of 275,000 b/d); UraiNefteGaz (87,000 b/d); and KogalymNefteGaz (475,000 b/d). In 1995 LUKoil took from RosNeft four producers which had agreed to merge with it: PermNeft (170,000 b/d); NizhnevolzhskNeft (52,000 b/d); KaliningradmorNefteGaz in the north-west (12,000 b/d); and AstrakhanNeft in the Russian the Caucasus (2,000 b/d). It began its vertical integration in 1993 by taking in one oil refining firm, VolgogradNeftePererabotka (with a 188,000 b/d plant at Volgograd with a usable capacity of 100,000 b/d). In 1995 LUKoil took from RosNeft three refining firms: PermNefteOrgsintez (278,000 b/d refinery in Perm being partly used); a smaller plant at Novoufimsk, the Urals; and the large Ufa refining complex in Bashkortostan (whose capacity once was over 900,000 b/d but now is about 100,000 b/d). In late 1999 it got the 150,000 b/d Ukhta refinery as part of the KomiTek deal.

LUKoil is modernising these refineries so that, together with other plants being acquired fully or partly elsewhere, its refining capacity should reach 1m b/d by 2005. This would include a new 180,000 b/d plant, being built in an area 30 km from Novorossyisk, called Southern Oil Refinery. The refineries generate cash but produce too much fuel oil.

The group has built an oil products pipeline linking its Perm refinery, on the Volga River, to Moscow and other markets including Tatarstan. This has joined an existing line for products exports from Omsk refinery in Siberia to Europe, which enables LUKoil's marketing units to expand in premium European regions. The group is building up a fleet for its shipping units, with one at Astrakhan where barge traffic along the Volga River links Russia's refining centres to the Caspian Sea. Other companies in the group include construction firms and units providing various services, such as LUKoilNefteAvtomatika, RostovNeftekh-improekt, Uraiskoe, and VolgogradNefteProdukt-Avtomatika. LUKoil was registered on the Russian stock exchange on April 5, 1993. It was not fully consolidated until 1995. It was the first to convert "daughter shares" into shares of the holding company and the exchange ended on Jan. 1, 1996. It was the first to enter foreign capital markets.

Among foreign partners in its system is Agip. LukAgip is their JV investing in Central Asia and North Africa (see Part 4). In the ConocoPhillips-operated Polar Lights in Russia's far north, LUKoil's AGD holds 30% and RosNeft has 20%. The US major holds 50%. LUKoil is branching into the power business. In late 2001 it set up a JV with the power group UES for electricity to be generated and sold where LUKoil has refineries.

LUKoil said in its annual report that most of its exploration work in 2003 was focused on promising new regions of the Timano-Pechora oil province, the Caspian Sea and the Bolshekhetskaya Basin. The increase in reserves due to geological work in 2003 was 169.7m tons of fuel equivalent (197m tons in 2002). In 2003 it found 13 oil fields, one gas/condensate field, one oil and gas field and 14 oil-bearing strata at previously discovered fields. In 2003 LUKoil analysed 14,600 km of 2D seismic profiles (10,900 km in 2002) and 2,400 sq km of 3D seismic (14% more than in 2002). An increase in the volume of seismic exploration in 2004 will enable clarification of how geological strata are structured and optimise geographical targeting of search and exploration drilling. LUKoil's subsidiaries obtained 12 new licences for sub-soil development in 2003, including one new licence for hydrocarbon production.

As of Jan. 1, 2004, LUKoil firms had 410 licences on their balance sheets, including 359 giving production rights and 51 giving exploration rights (including production). The main task of geological work in the reporting period was replacement of produced oil by new industrial-category reserves and preparation of fields for rapid launch of production in the North Caspian region, and in the Nenets and Yamalo-Nenets Autonomous districts. Its share of drilling was 3,113,000 metres, and spending on exploration was $37.3m. The addition of recoverable reserves was 1.7m tons (12.5m barrels).

To raise efficiency of exploration and achieve rapid growth of reserves, LUKoil imposed more stringent requirements for geophysical methods used. It says the latest modifications of seismic exploration provide additional information on inner structuring, lithology, and other qualities of oil-bearing strata, and make it easier to predict hydrocarbon saturation. This reduces risks in search and exploratory drilling, reducing the number of dry or low-productivity wells and, ultimately, increasing overall E&P efficiency. The high quality of discovery of productive strata, innovative means of studying well logs, use of methods for increasing flow have made it possible to achieve high debits from complex reservoirs. Use of interval testing of formations during drilling, oriented to core samples or gas indicators, has made it possible to increase the amount of information obtained from drilling and the exploration process as a whole. The volume of exploration drilling was 1.1943m metres (1.089m metres in Russia and 104,600 metres abroad) - 97,000 metres less than in 2002. LUKoil and JV oil production in 2003 totalled 81.5m tons, of which 78.6m tons in Russia. Subsidiaries and JVs produced at 311 fields, and 14 new fields came on stream, with 590 new producing wells and 306 injection wells put into operation. Average production per well rose from 24.4 tons/day in 2002 to 35.7 t/d in 2003, including an output increase by horizontal wells from 38.5 t/d to 53.5 t/d.

LUKoil's capacity as of Jan. 1, 2004, consisted of 26,812 producing wells (of which 21,844 were in production) and it had 7,780 injection wells (5,133 under pressure). It raised gas production by 11% to 5.7 BCM, including 1.3 BCM of non-associated gas. In Russia the group produced 4.2 BCM of associated gas and 0.5 BCM of non-associated gas. The total number of gas production wells at the start of 2004 was 313, of which 250 were operational, so the share of idle wells was 20.1%. The rate of use of associated gas is a key indicator of LUKoil's progress in gas sector development. This rose to 81% in 2003 from 74.6% in 2002.

Efficient use for associated gas for turbine generators close to the fields has cut spending on electricity and flaring, thus cutting production costs. Installation of gas-fired IPP generation has begun at the production units of OAO Arkhangelskgeoldobycha. A deal with Gazprom for supply of gas produced at LUKoil's Nakhodkinskoye field of the Bolshehetskaya Basin, Yamalo-Nenetskiy Autonomous District, was concluded in the framework of a strategic partnership for 2002-2005.

LUKoil's accounts now are issued under US Generally Accepted Accounting Principles (GAAP). LUKoil's target is to raise its oil output to 2.8-3.2m b/d and gas production to 100 BCM/year by 2010-2015.

In July 2002 LUKoil revealed its ownership structure. It had to do that to get a listing on the London stock exchange, because the Moscow government intended to sell a 5.9% stake in the group. Moscow later cancelled the sale because Lukoil's value had fallen below a previously anticipated level. (LUKoil had long refused even to publish financials in line with US accounting standards). The main shareholders then were as follows:

The Russian government, 13.1%. Its cancellation of the 5.9% sale - which would have represented the largest ever offering of a stake in a Russian oil company - came despite an over-subscription by international investors. The government received orders for 16.5m American Depositary Receipts (ADRs), although only 12.5m were being put on offer. LUKoil's value on July 31, 2002, the day before the planned sale, settled at $14.22 per share. The government's asking price was said to have been $56 for each ADR, equivalent to $14 per ordinary share, in view of an announcement by LUKoil in the previous week that its profits for the first quarter of 2002 had dropped 64.3% to $243m compared to $680m in the first quarter of 2001.

The US-based Capital Group, 10.8%.

LUKoil's President and CEO Alekperov, 10.4%. This meant he was a dollar billionaire on paper. He earned an annual salary of $1.5m, plus a bonus of up to $2.2m/year, which almost matches the wages of top executives in world oil majors like ExxonMobil and BP. He once said LUKoil could buy ExxonMobil "within 15 years".

Nikoil, an investment bank linked to LUKoil, 6.7%.

Niloil's CEO Nikolai Tsvetkov, 5.3%.

LUKoil Vice President and close aide to Alekperov Leonid Fedoun, 4.6%.

A 258-page ADR prospectus published in July 2002 showed that, with the exception of these shareholders, LUKoil was controlled through a number of nominee trusts. The ultimate beneficiaries of these trusts were not disclosed. On Aug. 5, 2002 Petroleum Argus mentioned a Cyprus-based company, Reforma Investments, which it said had bought a 9% stake in LUKoil at an auction in 1999. Argus quoted Russian government officials as saying top LUKoil executives were behind Reforma - noting that, if this was the case, Alekperov's personal stake could be larger than reported. The FT on July 31, 2002 said: "A more diluted, less cohesive ownership structure might help to explain why, in the past, LUKoil has had difficulty in cutting costs, or articulating a clear strategy". It quoted Moscow-based analyst Eric Kraus as explaining: "LUKoil is a loose confederation of warring tribes". Kraus, an independent, once worked for Nikoil.

In early 2001 BP sold a 7% LUKoil stake it had inherited from Arco, which the Anglo-US major absorbed in 2000, in two tranches for $657m. The second tranche was oversubscribed by a factor of 42. Thus BP made a profit of $277m as Arco had bought the stake for $380m. BP said the stake was too small to carry any decision-making influence in LUKoil.

The government is selling 7.59% in LUKoil at an open auction due in mid-September. Based on the current valuation of LUKoil, this should be worth between $1.8-1.9 bn. It is understood that the Kremlin is insisting on a minimum of $1.9 bn. It is said this is all the remaining stake of the government in LUKoil. Among the top contenders for this is ConocoPhillips, LUKoil's partner in the far north. Alekperov and the CEO of ConocoPhillips, James Mulva, met with President Putin in July. Putin was quoted as assuring Mulva that his firm's investment plans in Russia will be backed by Moscow. ChevronTexaco is another contender to invest in a big way in Russia.

LUKoil in 2002 restructured and consolidated management and operations in Moscow in order to improve its profitability, following criticism from shareholders as operating costs were higher than those of other Russian oil companies. It appointed non-executive directors to its board for the first time. One of these is former ChevronTexaco deputy chairman Richard Matzke, advising Alekperov on development of LUKoil's upstream assets. Another is Mark Mobius, executive director of Templeton Investment Management, a firm which acts on behalf of Western stock investors and is one of the largest players in the shares of Russia's blue chip companies (see detailed background in Vol. 59, OMT No. 11).

In early 2004, LUKoil said it would focus on exports at the expense of the domestic market in an effort to capitalise on high prices. Company VP Leonid Fedun, who heads the strategic planning and investment analysis division, said: "Oil exports keep growing, and sales in the internal market are going down. We hope that in 2004 we will practically stop selling oil" domestically. LUKoil's sales abroad fetch better prices, and selling less crude within Russia "will increase the incomes of our shareholders", he said (see Part 3).
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Publication:APS Review Oil Market Trends
Date:Aug 23, 2004
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Previous Article:RUSSIA - Part 2 - The Oil & Gas Producers.
Next Article:RUSSIA - Part 3 - Oil Exports Soar; Logistics Expanding.


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