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The Sunday Times: Rising Rosneft plans to join the BP league

EXTRACT: Rosneft and BP are already partners on Sakhalin 5, an exploration block off the Russian island above Japan which could prove as big as the giant Sakhalin 2 project being developed by Shell.

THE ARTICLE

July 23, 2006

After the biggest float ever in the industry, the chief executive of the Russian oil giant reveals his vision to Tracey Boles 
 
THE chief executive of Rosneft owes his rise to the top of the Russian oil giant to an act of God. In 1995, when Sergei Bogdanchikov was working as general director of a Rosneft subsidiary on the Russian island of Sakhalin, an earthquake struck.

He organised rescue efforts so effectively that he received a medal of honour for his work and came to the notice of the Kremlin. In 1998, he was rewarded again when he was made chief executive of Rosneft. 
 
Given his background, it is little wonder he shrugged off challenges that could have put paid to his latest task — bringing Rosneft to the stock market in London and Moscow. For weeks, top London fund managers had warned that Rosneft carried an unacceptable level of legal risk. At the eleventh hour, the company faced the threat of a High Court action that could have blocked the float.

But Bogdanchikov ploughed on regardless and the $10.4 billion (£5.6 billion) fundraising went ahead last week, giving Rosneft a market value of $80 billion. It was the fifth-biggest flotation ever.

The market debut is an attempt to gain credibility in the West. Bogdanchikov would like to propel Rosneft into the same league as oil giants BP or Exxon in terms of production. Rosneft’s turbulent past could catch up with it, however, scuppering his carefully laid plans.

In London last Wednesday for Rosneft’s first full day of trading, Bogdanchikov, slight and dapper with deep laughter lines that belie his stern reputation, said: “I am happy with how it has started. The flotation was the biggest in the whole oil and gas industry, the biggest in the Russian economy and the fifth-largest worldwide.

“Increasing capitalisation is very important. We want it to be higher than any Russian oil company might have. Otherwise investors will put their money in other Russian oil companies.” A higher market value could tempt the Russian government to sell off more of its stake in Rosneft at some future date.

The flotation caps the company’s rocketing rise. Until a few years ago, Rosneft was considered to be among the second tier of Russia’s oil groups — a holding pen for government oil assets left over after the wave of privatisations in the 1990s.

It was transformed by the intervention of the Kremlin. It was the main beneficiary when Yukos, the oil group created by Mikhail Khodorkovsky, collapsed in 2004 after he was jailed for tax evasion and fraud.

Rosneft acquired Yukos’s Yuganskneftegaz field, its main asset, after a controversial auction, won by an unknown Russian company that sold itself within days to Rosneft. The giant field now accounts for 70% of Rosneft’s oil production, helping to raise the total output to 80m tonnes a year from 12m tonnes eight years ago when Bogdanchikov took control of the company.

For the past year, Bogdanchikov, 48, has been working on Rosneft’s flotation, into which he put $950,000 of his own money. Now his priority is to fulfil the promises made to investors, primarily by raising oil production.

Rosneft has proven reserves of 15 billion barrels of oil — more than Exxon or BP and second only to Russian rival Lukoil among the world’s public oil companies — but it produces less oil than its western peers.

Bogdanchikov, who speaks English but prefers to talk through a Russian interpreter, wants to increase production from 80m tonnes a year at present to 100m tonnes by 2010, and 140m tonnes by 2015, equivalent to 2.8m barrels of oil a day. Production costs are well below those of western rivals at $2.1 a barrel.

The newly floated company also intends to expand through acquisitions or joint ventures with partners that include Britain’s BP. It has earmarked $3 billion to spend on downstream assets such as refineries and $15 billion on upstream exploration and production.

Bogdanchikov, an oil-refinery engineer by training who has worked in the oil and gas industry since 1981, is looking all over the world for licences or companies to buy. He said: “If the rate of return is over 20%, we will invest, regardless of location. If it is below 20%, we will not invest. The investment criterion, whether upstream or downstream, is efficiency.”

BP, which invested $1 billion in the Rosneft flotation, is at the heart of Rosneft’s oil exploration plans. Bogdanchikov said: “(BP’s involvement) is a big honour for us. We consider it a good partnership.”

Rosneft and BP are already partners on Sakhalin 5, an exploration block off the Russian island above Japan which could prove as big as the giant Sakhalin 2 project being developed by Shell. Two fields have already been discovered and new wells are being drilled. But co-operation between the two companies will not stop there. Bogdanchikov said: “We are studying similar projects in the Russian Federation.” 
 
To help fund his ambitious investment plans, Bogdanchikov may even dip into any money Rosneft recovers from Yukos, which is likely to be declared bankrupt at a Moscow hearing on August 1.

Sources close to Rosneft said it may also go after Yukos’s refineries if the assets are put up for sale after a bankruptcy.

Bogdanchikov has little sympathy for Yukos or its founder Khodorkovsky, who is languishing in a Siberian jail after being convicted of tax evasion and fraud.

He said: “Name a country where tax evasion is welcome. Tax evasion is a kind of terrorism. Nobody likes people who steal. They are just grabbing money. It is financial terrorism.”

Yukos and Rosneft are deeply entwined as a result of Yuganskneftegaz. Rosneft is trying to recover $3 billion of debt allegedly owed to Yuganskneftegaz by Yukos.

Meanwhile, Yukos investors who lost out when the company was forcibly broken up after it hit tax troubles have launched a number of lawsuits against both Russia and Rosneft.

What could be the biggest of the Yukos lawsuits has been filed by investors seeking billions in damages against the Russian Federation. The case, to be heard in The Hague, may expose Rosneft to a substantial liability. Tim Osborne, director of GML, formerly Group Menatep, which owns a 51% stake in Yukos and is the main plaintiff in the case, said claims against Russia could top $50 billion, but the lawsuit, under the energy charter treaty, could take until 2010 to resolve.

Yukos, which has threatened a “lifetime of litigation” over its lost assets, which it claims have been “looted” from the company, is also seeking $14 billion in damages in Russia over the controversial auction that led to Yuganskneftegaz being sold. The field went to a mysterious company, Baikal Finance Group, for $9.3 billion and was almost immediately bought by Rosneft. Yuganskneftegaz is now estimated to be worth $38 billion.

Bogdanchikov, unwilling to see anything stand in the way of his plans for Rosneft, dismisses the threat of litigation. He said: “Let me give you a fact. In 2005, Yukos didn’t win a case against us in Russia. There are other similar court cases that Yukos has not won.”

He may play down the risk, but many pages of the Rosneft flotation prospectus are devoted to it. It is thought Rosneft’s management wanted to list in London for the prestige and credibility that come from complying with more exacting listing standards, and responding to demanding investors.

Bogdanchikov said: “I have had hundreds of meetings with bankers, analysts and fund managers. They have been very good teachers. They gave us a better idea of our problems, strategies and bottlenecks — what we should be focusing on.” He said that the company may appoint more non-executive directors than the three it has at the moment.

Strong demand for the shares may have shaken off the legal and governance concerns for now, but the issues could come back to haunt Rosneft — and its new investors.

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