Lukoil share issue a response to growing competition among Russian oil firms

Dec. 17, 2002
Economic necessity is proving to be the mother of invention for Russia's state-held OAO Lukoil, as it comes to grips with a rising tide of competition from several emerging Russian oil companies.

By an OGJ correspondent

NEW YORK, Dec. 17 -- Economic necessity is the proving to be the mother of invention for Russia's state-controlled OAO Lukoil, as it comes to grips with a rising tide of competition from several emerging Russian oil companies.

At the end of last month, Russia quietly put up for sale a 5.9% stake, or 50 million shares, in Lukoil. Morgan Stanley handled the offering on the London Stock Exchange, and the issuance garnered close to $800 million. That's nearly $87 million more than if the Russians had consummated the financial transaction back in July, when it originally planned the share issue. "Obviously, the Russian government needed to raise capital, and this reduces the state's stake in Lukoil; from a privatization perspective this is a good thing," said Julia Nanay, a director of Washington, DC-based consulting group Petroleum Finance Co. who specializes in the Russian oil market.

A big reason for the Russian government's sale of Lukoil shares on the public market: massive foreign debt payments coming due next year, expected to peak in 2003 at $17.9 billion with $10 billion in principal payments and the rest in interest. While Russia faces huge foreign debt obligations and is trying to raise cash, Nanay says Lukoil must face up to several other challenges, as well.

More competition
"Lukoil is starting to wake up to the fact that there are other Russian oil companies coming up the ranks, like (OAO) Yukos (Oil Co.), that are overtaking them in terms of production and efficiency," she said.

Nanay said it is easier for western oil companies to get a "clearer sense" where emerging Russia oil companies such as Yukos, OAO Sibneft, Surgutneftegas, and Tyumen Oil Co. (TNK) are strategically placing their investments.

On Dec. 6, Bloomberg reported, Yukos "may overtake OAO Lukoil as Russia's biggest oil producer if Yukos meets plans to boost oil production 19% in 2003." The report goes onto say that Yukos plans to pump 83 million tonnes (1.66 million b/d) of oil next year, while Lukoil says it expects to increase production 5.1% to 82 million tonnes of oil in 2003.

"These new Russian oil companies haven't spread themselves as thin as Lukoil has, and now Lukoil is getting more focused on where they are going to devote their resources, as they shed assets and raise cash," Nanay said. Lukoil expects net profits to fall to $2 billion in 2002, down from $2.11 billion last year. Lukoil Pres. Vagit Alkperov has said Russia's biggest oil producer expects net profits to tumble to $1.5-1.7 billion in 2003.

However, Lukoil's outlook isn't entirely bleak. On Dec. 6, Standard & Poor's upgraded Lukoil's long-term corporate credit rating from B+ to BB-, giving it a stable outlook.

"The revised rating is based on the general improvement in the operating environment for Russian oil companies and reflects Lukoil's standing as the Russian federation's largest oil company in terms of crude reserves, production, and exports, tempered by its moderate cost structure and leveraged financial profile," said Standard & Poor's credit analyst Eric Tanguy, in a company statement.

Governance concerns
Western firms dealing with Lukoil have voiced concerns over its management tactics and lack of internal transparency.

Aware of those concerns, back in June, Lukoil named two western executives to its board of directors: Richard Matzke, former vice-chairman of ChevronTexaco Corp., and J. Mark Mobius, managing director of the Emerging Markets Group of San Mateo, Calif.-based investment management company Franklin Templeton Group.

"Russian oil companies are either hiring western managers directly or bringing western managers on their boards, and even contracting western oil service companies, as they all are trying to boost production and exports, in an effort to become more like western oil companies," Nanay said.

"The big question is: Will western oil companies get PSAs (production-sharing agreements) in Russia and gain access to not only onshore Russian PSAs but access to pipelines and (thereby) taking greater control over all their investments in Russia?" she said.

Production surge
Nanay cited current forecasts that have Russia producing more than 8 million b/d of oil in 2003, with 3 million b/d available for export. Russia's stated goal is to reach 9 million b/d of production by 2005.

"That's a very big increase in a short period of time, but going forward, will Russia's pipeline infrastructure for oil exports be able to support such rapid growth?" Nanay asked.

While the Organization of Petroleum Exporting Countries has made output cuts in 2002, Russia's oil production has surged to 74.752 million tonnes, or 13%, according to Interfax, a Russian new agency, which quoted a source in the Russian State Customs Committee on Dec. 5.

And it's not only Russia where western oil foreign direct investment dollars are going. Kazakhstan and Azerbaijan are also vying for these massive exploration, development, production, and pipeline projects.

If the market becomes flooded with Russian, Azeri, and Kazakh oil, then the price (of oil) over the next few years is bound to go down, and that's a problem for them and all oil producers," Nanay said.

"In the end, getting beyond 9 million b/d for Russia may be more difficult than some expect and will require financing for major exploration and infrastructural projects. How much foreign investment Russia attracts will determine its success," Nanay said.

Although Russian oil officials weren't involved in the talks, rising Russian and Eurasian oil exports to the US and Asia were on the agenda Dec. 12, when OPEC met in Vienna to hammer out a new accord on production quotas for 2003 (OGJ Online, Dec. 12, 2002).