Globe & Mail (Canada): SPECIAL REPORT: ENERGY: This oligarch knows how to survive

GLOBAL ENERGY REPORTER SHAWN McCARTHY looks at the head of Lukoil, the key to Russia’s bid to build oil firms that can compete with Western majors

MOSCOW — OAO Lukoil chief executive officer CEO Vagit Alekperov is a Darwinian success story: An oil industry oligarch who has evolved and thrived despite President Vladimir Putin’s drive to reassert state control over Russia’s energy sector.

A former deputy energy minister, Mr. Alekperov was president of the Soviet-era oil company that was privatized in 1993 to become Lukoil, a process that made billionaires of the company’s top executives, including him.

Many of the other most-prominent oligarchs who controlled Russia’s newly privatized energy companies in the 1990s have been sidelined, or worse. Some are in jail, others have sold out to state-owned companies and gone into exile, and still others are facing pressure from government regulators that is expected to result in a sale.

Mr. Alekperov has not only survived that trend, his company has ignored the growing hostility in Russia toward foreign oil companies.

U.S. oil major ConocoPhillips Co. of Houston — which in 2004 bought the state’s remaining 7.6-per-cent interest in Lukoil — is now its largest single shareholder, with a 20-per-cent stake.

Despite Mr. Putin’s clear preference for state-owned companies, and despite the American influence, Lukoil has emerged as national standard-bearer in Russia’s effort to build international oil companies that can compete globally with Western majors.

Moscow-based Lukoil, the biggest oil producer in Russia, trails only Saudi Arabia in daily crude output. And among the world’s privately controlled oil firms, it is second in production and reserves only Texas-based Exxon Mobil Corp.

On its home turf, Lukoil faces challenges from state-controlled OAO Gazprom and OAO Rosneft, which are benefiting from Mr. Putin’s desire to bring “strategic assets” — that is, major oil and natural gas developments — under the sway of the government. But on foreign soil, it’s a different story. Mr. Putin has clearly designated Lukoil to be a national champion as he looks to extend Russia’s energy might into overseas markets.

Mr. Alekperov last month visited Saudi Arabia and Qatar with the Russian President. The oil executive signed commercial agreements, while Mr. Putin talked about increasing Russia’s influence in the volatile region.

Lukoil said recently it will speed its globalization effort, doubling capital expenditures to $10-billion (U.S.) a year over the next 10 years.

In addition to producing properties, the company is investing heavily in refinery and marketing assets, both in Russia and around the world, to profit from integration and to make Lukoil a global brand.

Motorists in the northeastern United States have been filling up at Lukoil stations since last year after the company rebranded the facilities it had purchased from Los Angeles-based Getty Oil Co. and ConocoPhillips over the past four years. In fact, Lukoil now has a monopoly on the Jersey Turnpike, as well as a Manhattan gas station that was officially opened by Mr. Putin himself.

Lukoil vice-president Leonid Fedun said in an interview that the company’s top managers have long been willing to invest where the most profitable resources are to be found, even though more than 95 per cent of its reserves are located in Russia.

Mr. Fedun, 50, became a billionaire as a result of his role in privatizing the former Soviet oil company 14 years ago. Forbes magazine lists his fortune at $4-billion (U.S.) — a rung up from Paul Desmarais, chairman of Montreal-based Power Corp., and $100-million shy of Italian designer Giorgo Armani.

“From its inception, Lukoil has always striven to broaden the area of its operations,” Mr. Fedun said. “We have always been aware of how precious reserves are to a company, and our goal was to acquire as many reserves as possible, at the lowest price available.”

Mr. Alekperov, 56, and his associates at Lukoil are among the most successful of the so-called “oligarchs,” men who made billions by taking control of Soviet-era companies as they were privatized by former president Boris Yeltsin. The son of an oil field worker, Mr. Alekperov survived and thrived by remaining on good terms with Mr. Putin, and staying far away from politics. He is now worth an estimated $11-billion (U.S.).

Valery Nesterov, an analyst with the Troika Dialog investment house in Moscow, said Mr. Alekperov has proven politically adept, remaining “quite loyal to the Kremlin” throughout the reign of Mr. Putin. Lukoil “enjoys all possible political support in foreign markets,” he added, just as Western companies do from their governments.

Other oil oligarchs have not fared so well, as they ran aground on Mr. Putin’s policy of reasserting the state’s dominance in the strategic energy sector.

Mikhail Khodorkovsky once controlled Russia’s then-largest oil company, OAO Yukos, until he was prosecuted for tax evasion and imprisoned; the company’s assets have been bought out of bankruptcy by state-owned OAO Rosneft and OAO Gazprom.

Mr. Fedun said Lukoil has not participated in the bidding for Yukos assets. “We’re hunting elsewhere,” he said.

Roman Abramovich, Russia’s wealthiest man, two years ago sold out his shares in oil giant OAO Sibneft to Gazprom for $13-billion (U.S.), and now lives in London. And a group of Russian billionaires, who control the country’s fourth-largest oil company, TNK-BP, in partnership with the British oil giant BP PLC, are reportedly being squeezed to sell their stake to Gazprom.

Similarly, foreign oil companies have run into problems in Russia. Royal Dutch Shell PLC was pressured into selling its majority stake in the rich Sakhalin-2 oil and gas project to Gazprom, while French giant Total SA is now being threatened with having its licence on the Kharyaga project revoked due to regulatory problems.

But Mr. Putin is apparently comfortable with Conoco’s 20-per-cent stake in Lukoil — an arrangement that provides the Russian major much-needed access to Conoco’s refining and marketing expertise, and gives the U.S. company the ability to book its share of Lukoil’s vast reserve base.

Mr. Fedun said Lukoil is satisfied with its role as Russia’s national champion. “Why not? If this flag-carrying is profitable to our shareholders, I don’t mind it,” he said, noting that nearly half of Lukoil’s shareholders are non-Russian.

And despite onerous Russian taxes, Lukoil has proved extremely profitable. Revenue doubled over two years to an estimated $68-billion (U.S.) in 2006, while profit rose to an estimated $7.8-billion from $4.2-billion in 2004.

The company is focusing on increasing its oil and gas production outside of Russia, due in part to the country’s onerous taxation regime. It has major projects in Kazakhstan and Azerbaijan, as well as development efforts in Venezuela, Iran and Saudi Arabia.

And it is investing heavily in refining capacity within Russia. Faced with high taxes on crude production and growing demand for petroleum product in the country, refining and marketing is an increasingly profitable side of the business, Mr. Fedun said.

Lukoil is also eyeing some major investments in refining and marketing in foreign downstream markets, including North America. So far, the company has been limited to gasoline stations in Europe and the United States, but is keen to purchase refining operations.

Mr. Fedun said downstream assets have been priced too high because profit margins had been attractive. Now that they’re lower on the refining and marketing end of the business, Lukoil expects to be an acquirer.

Still, Mr. Nesterov suspects the Russian company was stymied by more than just market conditions — he doubts U.S. and European politicians will welcome with open arms a Russian company into such a key sector.

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Lukoil at a glance

$68-billion

Projected 2006 revenue (in U.S. dollars) versus $34-billion in 2004

$7.8-billion

Projected 2006 profit versus $4.3-billion in 2004

20.36 billion

Reserves of barrels of oil equivalent, a reserves-to-production ratio of 24.3 years

26.6 trillion

Reserves of cubic feet of gas, a reserves-to-production ratio of 126 years

No. 2

Among non-state companies world wide, reserves are second only to Exxon Mobil

Largest shareholders

Houston-based ConocoPhillips is Lukoil’s largest shareholder, with 20 per cent. Other major shareholders include company founders Vagit Alekperov, Leonid Fedun and Nikolai Tsvetkov.Foreign operations

Lukoil has major projects in Kazakhstan and Azerbaijan and is exploring developments in Iran, Saudi Arabia and Venezuela. It has refineries in Ukraine and Bulgaria. In the United States, Lukoil has 2,000 gas stations in 13 states.

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