A recent flurry of merger and acquisition activity is about to give the Russian oil sector a major facelift—and possibly add to the ranks of the world's supermajor oil companies.
Two megadeals and one merely large acquisition involving Russian oil and gas assets have been announced in the past 3 months:
- Plans by BP PLC and two Russian investor groups to invest $6.75 billion in a new company, TNK-BP, that would incorporate major Russian oil companies Tyumen Oil Co. (TNK) and Sidanco Oil Co. (OGJ Online, Feb. 17, 2003).
- The $35 billion proposed merger of Russian oil giants OAO Yukos and OAO Sibneft into YukosSibneft Oil Co. (OGJ Online, Apr. 22, 2003).
- Marathon Oil Corp.'s agreement to acquire Khanty Mansiysk Oil Corp. (KMOC) for $275 million (OGJ Online, Apr. 23, 2003).
With these transactions, a few players in Russia have gotten bigger, while the number of Russian oil industry acquisition targets has gotten smaller. Analysts are mixed in their opinions as to whether this closes off or creates the stimulus for further western investment in the Russian energy sector.
The Yukos-Sibneft merger would vault the resulting company above OAO Lukoil as Russia's leading oil company, and it would enter the ranks of the supermajors—BP, ExxonMobil Corp., and Royal Dutch/Shell Group—at least in terms of production and reserves.
If approved by shareholders and regulators, the deal would result in a conglomerate with $15 billion/year in revenues and a market value of close to $35 billion.
When it was announced, the proposed TNK-BP holding company was envisioned as Russia's third largest oil company.
Marathon's announced intent to buy KMOC, a US-based, privately held oil firm with operations in Western Siberia, is further evidence that western companies are positioning themselves in a rapidly consolidating Russian market.
Russian oil sector reshaping
"These two transactions, BP-TNK and Yukos-Sibneft, completely reshape the Russian energy sector. The number of Russian oil firms being targeted by western firms has gotten much smaller than before," said Vladimir Lechtman, partner at Jones Day, a Washington, DC-based international law firm. Lechtman was involved in the negotiations between BP and the TNK-Sidanco investment groups and says he is bullish on Russian oil opportunities.
And while there are now fewer players in the Russian energy market, the new Yukos-Sibneft merger vaults the Russians into a small circle of the biggest oil companies in the world.
"The significance of the Yukos-Sibneft merger is (that) it creates a new major competitor in the oil industry. So far, it's only a competitor in Russia, but in the future, it could have international ambitions. It's a new, serious player in the international oil business," says Julia Nanay, senior director at Petroleum Finance Corp. (PFC), a Washington, DC-based energy consultancy.
"The rationale behind the merger is similar to the [other industry] consolidation we've been seeing, but the Yukos-Sibneft deal shows the Russian oil players to be the equals of the oil majors," said Robert Ebel, director of the energy program at the Center for Strategic & International Studies, a Washington, DC-based think tank.
Response to megadeal
Soon after news of the deal, Moody's on Apr. 23 affirmed Yukos's credit rating, while saying it would keep Sibneft "under review for possible downgrade." Moody's release reiterated that the two Russian oil companies have proven reserves of 19.4 billion boe and production of 2.3 million b/d. Moody's went on to say that "merger plans are still at a relatively early stage and that the transaction will likely take the rest of this year to complete."
The credit rating agency noted, "The intended merger of Yukos, the second-largest Russian oil and gas company, and Sibneft, the fifth-largest, will create a very substantial oil company both within Russia, where it will account for almost a third of total domestic production, and by international standards. The new group, to be known as YukosSibneft, will have total hydrocarbon reserves on a par with the supermajors. By production YukosSibneft will rank among the top half-dozen oil companies in the world."
However, despite the lofty praise for the deal, analysts said that Sibneft's debt of $1.7 billion is close to its debt ceiling, which may have spurred the company to strike a deal with either a domestic or foreign partner.
Citibank has been assisting Sibneft sell $900 million worth of its corporate debt since early 2002. Citibank, along with UBS Warburg LLC, Credit Suisse First Boston, Goldman Sachs, and Deutsche Bank AG are said to be bidding for a variety of investment bank financing associated with energy projects in Russia.
There is no question that the Yukos-Sibneft merged entity will have far greater access to debt markets, with better chances of being involved in large-scale projects within Russia and elsewhere around the world. Yukos is said to have amassed more than $5 billion that could go towards acquisitions in the future. As a result of the deal, Yukos's plans to be listed on the New York Stock Exchange are likely to be delayed until 2004.
Reserves questions
But while there is excitement about the deal, there also may be reason for pause. Initial press reports said the combined Yukos-Sibneft would have total proven reserves of 18.4 billion bbl of oil and 5.9 tcf of natural gas reserves, based upon yearend 2001 estimates, as calculated in accordance with the Society of Petroleum Engineers' methodology. Yukos-Sibneft said its crude oil production would be 2.3 million b/d, or 29% of Russia's total. The Yukos-Sibneft figure includes Sibneft's share of Slavneft OAO production (OGJ, Jan. 6, 2003, p. 31). Using 2002 figures, this amounts to 754.2 million bbl/year of oil.
Some press reports and Moody's Investor Service said the new company would have 19.4 billion boe, but Nanay told OGJ that PFC's research shows those numbers may not be correct.
"The press has been using 19.4 billion boe for their reference instead of 16.4 billion boe, which we think is more accurate," Nanay said. "We have used the SEC (US Securities and Exchange Commission) reserves data for both Sibneft and Yukos, which suggests a 9.961 billion boe figure for Yukos as opposed to the 12.6 billion boe number that is being used in the media. This makes the data comparable with the majors, which are reporting using SEC guidelines. In addition, we have added 50% of SlavneftUreserves into the mix, reflecting the end-2001 acquisition by Sibneft of half of the Slavneft reserves.
"So we end with Yukos-Sibneft reserves as at yearend 2001 equaling the sum of Yukos at 9.961 billion boe, Sibneft at 4.886 billion boe, and Slavneft's share at 1.553 billion boe, for a total of 16.4 billion boe.
"This places YukosSibneft in fourth place among the supermajors, behind ExxonMobil, BP (plus 50% of TNK-BP), and Shell, in terms of reserves. Crude production will stand at an equally impressive 2.06 million b/d, with growth in 2003 targeted at 20-25%, unparalleled for a firm of this size," Nanay said.
What's next
Will Russian consolidation lead to more foreign equity investments in these new larger firms? Analysts and experts on the Russian oil market have a variety of views as to whether this flurry of activity in Russia creates or limits new opportunities.
"This closes off Western oil firms from doing similar deals in Russia, with TNK hooking up with BP, and now the Yukos-Sibneft merger," Nanay said, adding that the consolidated YukosSibneft will have "participation in 14 refineries for a total refining capacity of 2 million b/d and over 2,600 service stations."
PFC's Energy Downstream Services report concluded, "The deal creates a clear monopoly position in Siberia."
But not everyone agrees that just because there are a smaller number of players now in the Russian market, that there aren't still investment opportunities for foreign oil companies.
"Consolidation has taken place within Russia; now there is the possibility that major western oil firms will take advantage of the change in scale and invest in much bigger enterprises," Lechtman said.
Who's next
It is still unclear which, if any, of the major western oil firms will acquire stakes in either of the two new entities. Recent speculation has turned to the possibility that western firms could bid for OAO Lukoil and Surgutneftegaz. These two other large Russian oil firms are run by former government officials and may not be as attractive to foreign investors because of their existing management and corporate structures.
Analysts said western oil firms may be more interested in some of the smaller potential acquisition candidates in Russia, including OAO Tatneft and OAO Bashneft.
But Lechtman said he thinks it is possible that companies, such as ExxonMobil, Shell, TotalFinaElf SA, or even ChevronTexaco Corp. could potentially be interested in taking "equity stakes" in either YukosSibneft or TNK-BP.
"I think an announcement of a major deal between a major western firm and one of the Russian oil ventures is possible this year, and it would probably be for at least a 25% stake," Lechtman said.
Ahead of the news of the Yukos-Sibneft merger, there were reports of rumors that Shell and TotalFinaElf were trying to acquire Sibneft. Analysts said they expected Shell and the other majors to continue to have discussions with the key players in the Russian energy sector. There are also reports that there was domestic political pressure for the all-Russian Yukos-Sibneft deal to get done.
"Yukos may have wanted to preempt another Western-type arrangement like the TNK deal with [BP]," Nanay said.
Scenarios
And as western oil companies decide if equity investments in either YukosSibneft or TNK-BP make sense, there are both promising and troubling scenarios being described by experts.
"You have Russian companies with reserves comparable to the major international oil companies, but with comparatively low valuations," Lechtman said.
"As the market [capitalization] of these merged Russian oil companies increases, and with the possible reduction of country risk, along with greater transparency, you are likely to see significant advances in lower production costs and advanced technological techniques," Lechtman said.
If and when the Yukos-Sibneft merger is complete, there are skeptics who aren't convinced that the major global oil companies will use this deal as a reason to step up their presence in the Russian oil market.
"It's questionable to me whether any of the western firms will invest in YukosSibneft, because they would not have the similar level of influence and control as BP has in its deal with TNK," Nanay said.
Ebel contended that "the majors could buy into these new, large Russian ventures, but I'm not sure how attractive those investments look right now," adding that the overall business climate in Russia "is far from settled."
PSA concerns
Ebel said the jury is still out whether the major multinational oil companies will be more interested in investing in Russia, and there have been some recent developments he says are troubling.
"The recent action by the Russian government towards turning down production sharing agreements is reason for concern. Russia is essentially rejecting PSAs, except on the very expensive offshore projects," Ebel said.
Nanay agreed, adding that Yukos Chairman and CEO Mikhail Khodorkovsky and Sibneft major shareholder and Russian businessman and politician Roman Abramovich stand to gain the most financially from the Yukos-Sibneft merger.
"Khodorkovsky wants to position himself as the gatekeeper to investment in the Russian oil sector and has been the lead lobbyist in Russia against production sharing agreements," Nanay said.
Controversial personalities
Several questions remain concerning the YukosSibneft deal, including how Sibneft's minority shareholders will be treated.
Close to 90% of Sibneft's shares are held by a core group led by Abramovich, who is expected to garner several billion dollars as a result of the transaction.
There are reports that Sibneft may have to exhibit greater financial transparency than it has in the past. If it does, it is likely it will become clear whether controversial, exiled business tycoon Boris Berezovsky actually has a stake in Sibneft. Berezovsky, living in exile in London, was arrested in March in connection with Russia's efforts to extradite him to stand trial on fraud charges. The Kremlin has accused him and a business associate of defrauding a local Russian government of millions of dollars.
Berezovsky was a media tycoon instrumental in the elections of both former President Boris Yeltsin and current President Vladimir Putin—although recently at odds with the latter.
The Moscow Times reported that Berezovsky "insisted that he still controls a stake in Sibneft, the company he created and then bought from the government for $100 million in a loans-for-shares deal in 1996. He declined to identify the size of his stake."
Sibneft on Wednesday denied Berezovsky has any ownership stake. "It's my understanding that Mr. Berezovsky is no longer a shareholder," a Sibneft spokesman told Moscow Times.
Analysts said that while Berezovsky may be a shareholder in Sibneft, his stake will be diluted by the Yukos merger.
The deal has been hailed by Russian government officials, and it is unclear if Berezovsky's involvement will politicize approval of the merger.
Marathon's entry
And despite the controversy and risks for western companies getting involved in the Russian oil market, the Marathon acquisition of KMOC indicates continued interest in the potential opportunities of the Russian market.
The companies said they plan to close the deal by mid-May, but Shell, which holds a 45% stake in KMOC, has until May 6 to make a matching offer for the shares it does not own, or approve the deal.
Other KMOC shareholders include J.P. Morgan Chase, American International Group, and the Brunswick Group.
KMOC, with headquarters in New York, is developing nine oil fields in the Khanty-Mansiysk region of Western Siberia.