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Polish News Bulletin: Petrolinwest’s Russian Purchase Upgrades Its Profile from Oil Exploration to Oil Extraction

EXTRACT: But the huge players can lose a lot in Russia too. The example of Shell or BP, who lost their licenses for gas extraction are good examples. The political risk is much higher.

Published: Jul 31, 2007

Listed Petrolinwest has oil. On Thursday the Ryszard Krauze-controlled company, which has been holding licenses for oil exploration in Russia and Kazakhstan for a while, bought a 50-percent stake in a group of Russian oil extraction firms. The documented deposits they own reach 35 million barrels.

Petrolinwest paid $100m. A further 100m, but in Petrolinwest shares this time, will be paid for the remaining stake in the group. The whole operation should be concluded by year-end, if only both sides reach agreement on its terms. It would make the owners of the Russian companies shareholders in Petrolinwest. But this is not all. According to Ryszard Krauze himself, Russian managers will start to play more important roles in Petrolinwest. “They are excellent professionals, knowing the ropes of the Russian market. We would like that group and its management to become the centre of consolidation of our Russian assets,” he told Wall Street Journal Polska in an interview.

The transaction has some unknowns, however. The name of the taken over group has not been revealed, because that is what the Russians demanded. It is uncertain in what Russian republic the company operates. Until recently, Petrolinwest’s activity in Russia was limited to the Komi Republic only, located in the north-east part of Russia. Petrolinwest bought 60-percent stakes in three companies holding oil search licences there. It is quite likely the currently being acquired group is functioning there too. But Krauze did not want to confirm this fact.

The key to the whole transaction lies in the category of controlled oil ? P1. This means that the 35 million barrels surely exist and can be extracted. But in comparison to the processing capacity of Polish petrol companies, the size of the oil field is not impressive. Grupa Lotos is supplied with more oil annually, while PKN Orlen receives three times as much oil each year.

Nonetheless for Petrolinwest ? as its main shareholders declares ? the pure fact of holding oil is crucial as it changes the company’s profile from an oil search business to oil extraction and search. “This is a fundamental thing for the company. It gives us positive cashflow,” Krauze argues.

Analysts are rather cautious in their assessments of Petrolinwest’s future share price growth. But they admit that launching oil extraction does change its financial prospects. “Such investments always bear considerable risk. But when the oil starts to flow, the return on investment is very high,” said Ludomir Zalewski, DM PKO BP analyst.

This year Russian companies are to earn $35mln on $165mln turnover. Petrolinwest’s plans stipulate doubling extraction profits next year. It would be the consequence of carrying out a $150mln investment programme. The company wants to spend $50mln on ten new drills and $100mln on preparing the deposits for extraction. It cannot be ruled out that it will acquire further deposits for the promise of seeing a sum like $100mln invested.

Transportation costs may be another risk factor concerning the Russian companies. They do not have direct access to a pipeline. Any extracted oil is transported to a terminal in lorries.

Below you will read a comment to Petrolinwest’s investments by former Economy Minister Janusz Steinhoff, an assessment of the oil firm’s Kazakh investment and an exclusive interview with Petrolinvest’s main shareholder Ryszard Krauze. – Investing in Russia Is Worth the Risk

Former Deputy PM and Economy Minister Janusz Steinhoff points out that the details of Petrolinwest’s transaction remain undisclosed. “We do not know the statutes of the Russian firms, nor the possibility of executing rights to shares. It is even uncertain which entity we are actually talking about.” Steinhoff remains an optimist, however. “Buying a majority shareholding seems to make sense. From the point of view of company interest, investing in the Russian private sector are conducted rationally. Russia’s expected entry into the WTO should civilise procedures in that country. That is why it is worth being there already.” – Petrolinwest Stronger in the East

The purchase of the Russian group strengthens Petrolinwest’s assets in the East. Nearly a year ago the company bought oil searching licences in Kazakstan. It is also present in the Russian Komi Republic. The company holds majority stakes in three companies: Peczora Petroleum, NK Siewiergeofizyka and Nieftiegeoserwis. The first two have licences for oil search and extraction, the third only for searching. The licences do not cover large areas, they do not exceed 800 square kilometres.

Information provided by Petrolinwest at the beginning of July suggested they could hold from 10 to 160 million barrels of oil. The newly bought deposits hold 35 million barrels. Can you hope for more? “It is too early to talk about it now. All this will be subject to our due diligence and a strategy currently being worked on,” said Ryszard Krauze, main shareholders in Petrolinwest.

Table. Oil extraction costs in various countries (in USD per barrel) Europe 15 US 14.5 World (average 13 Russia (Komi) 6 UAE 5 Algeria 4.9 Iran 4.7 Iraq 4.4 Kazakstan 4.0 Kuwait 3.8 Saudi Arabia 3.0 source: Wall Street Journal Polska

Irrespective of the size of the new oil deposits, transportation costs will be a problem. The deposits are not connected to any pipeline. The extracted oil has to be carried to the nearest pipe in trucks. According to specialists, the average daily extraction of 12,000 barrels a day, the additional costs of oil transport this way could cost a few million dollars annually.

The Kazakh assets have the same problem. Transportation costs there are even higher due to a poorly developed infrastructure. The licences in Kazakhstan lie on a territory regarded as belonging to the most oil-rich terrains in the world. Before Petrolinwest’s stock-market debut, its CEO Pawel Gricuk said: “We have an audit report assessing the potential of our Kazakh deposits at between a few million to a few billion barrels.”

Kazakhstan also offers very low extraction costs.

The current estimates will be made more precise by further drills, which are to begin in the next few weeks. The Cracow-based company PNiG and foreign companies: ENI’s Saipem and Aral Parker Kasp, drilling for Chevron, were contracted to conduct them. Petrolinwest hopes to find Kazakh oil in three-six months.

– Petrolinwest Will Try to Acquire Three More Oil Fields in Russia

You bought a company with its own oil in Russia, but we do not know too much about the transaction. We do not know the company’s name, we do not even know where the oil fields are. What exactly did you buy?

Ryszard Krauze: “This is a huge event for Petrolinwest, because it is fundamentally changing the company’s picture. From now on Petrolinwest will not only search for oil, but will also reap benefits from the oil sales extracted from the controlled deposits. We signed a letter of intent concerning the purchase of a 50-percent stake in a group of companies running oil extraction for many years. They all control oil extraction licences and oil fields holding documented 35 million barrels (classified in the highest category ? P1). The category means the existence of the deposits has been confirmed by research and the oil can be extracted. What is more important, the firms are extracting and selling oil already. They expect to record turnover of $160mln this year.”

What about profits?

“I cannot reveal all information yet. In 2007, it will be around $35mln.”

Another question mark. Why don’t you reveal the name of the company? When will you do it?

“The ban on disclosing the company’s name was part of the letter of intent we signed demanded by the Russian side. The expected closure of the transaction is set at 15 August. Then we will reveal who our partner is. I can only add that natural persons are the firm’s owners now and they all have decades of experience in the petrol sector. They have huge extraction and geological knowledge. This is valuable capital for us and surely one of the crucial elements of the transaction.”

You previously bought majority stakes in three search and extraction companies from the Komi Republic. How are you planning to increase your share in the companies you are buying now and when could it happen?

“We have time till the end of the year to discuss the issue of buying the remaining 50-percent stake. The transaction would swap shares in the bought companies for Petrolinwest stocks from a new issue. Thus, Petrolinwest would become a 100-percent owner of Russian companies, while their current shareholders would hold shares in Petrolinwest. Of course, this will be possible as long as we settle all terms.”

In the case of Polish petrol companies such as PKN Orlen or Grupa Lotos, the presence of Russians in their shareholding structures would raise fears both among the firms’ authorities and politicians. Isn’t Petrolinwest afraid of the Russian shareholders?

“Why would I be afraid? We are buying their companies. Their management, in our opinions excellent, gives us huge profits. They are great professionals. They know the ins and outs of Russian conditions and know how to move on the market. This is one of the most important assets. That is why when we take over the shares, we want this company and its management to consolidate the rest of our Russian assets.”

Does this mean that the purchase of this company will move the priority of your business from Kazakhstan to Russia?

“No. We were saying from the very beginning we are running investments in two countries: Kazakhstan and Russia. The current transaction is just a step forward in Russia. It also proves that our faith in the construction of friendly Polish-Russian relations has deep roots. It has nothing to do with Kazakhstan. Work in Kazakhstan is following its own rhythm and the whole investment programme prepared for Kazakh licences is being carried out as planned.”

So what does the takeover of a company extracting oil already mean for Petrolinwest?

“It changes Petrolinwest’s profile from oil search company to oil search and extraction company. This is extremely important for Petrolinwest as a whole. It gives positive cash flow. This is not just the possibility of having oil we have had so far. This is a concrete plan, which brings profits and favourable prospects.”

How favourable are they? 35 million barrels of oil are just a third of what Orlen processes each year.

“35 million barrels is a lot. As the deposits are well-documented, while all drills so far were done to extract oil, it seem that doubling extraction is just a matter of conducting further drills. We have agreed upon an investment programme with our Russian partners. Doubling extraction and profits in 2008 as well as the purchase of three other projects in Russia are its key elements. The fact that all previous drills on the fields provided oil proves that the transaction concerns reliable deposits.”

Will its success stimulate further acquisitions?

“I absolutely do not rule that out.”

You are investing in the Russia oil sector, a strategic and politically risky industry. Additionally, you are doing so while Polish relations with Russia are surrounded by political tension which hinders the development of mutual economic relations.

“Such a transaction will help improve those relations. It may show that Polish-Russian co-operation in business is something perfectly normal. We are not the first to do so: many companies functioning on various markets chose to invest in Russia and are successful there. Our entry into the petrol industry is no revolution. It certainly a step forward in constructing normal relations between Poland and Russia on economic level. I have not heard any information about us being treated badly. It is only a pity that our position is not as strong as the Western investors’ from the US, France or Germany.”

But the huge players can lose a lot in Russia too. The example of Shell or BP, who lost their licenses for gas extraction are good examples. The political risk is much higher.

“As far as I am concerned, these companies have not withdrawn from Russia, though it is true they limited their scope of activity. I do not want to comment on events connected with the gas, because it is a different market. I see no political risk to our business. Co-operation with the Russians is going smoothly and proves that you can do excellent business in Russia. Furthermore, good relations with local partners reduce all other risks. They facilitate correct and quick understanding of the surroundings and appropriate decision-making in line with the local regulations. It is extremely important to make sure all formal elements connected with business are all right. You need to take care of the environment and run your business in line with your licence. These are matters that are obvious everywhere, but gain huge meaning in Russia and the ability to be successful there.” \nc 04005000 \nc 11014001

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