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Lukoil (pg. 2)

By Barney Gimbel, writer
Last Updated: February 26, 2009: 4:56 PM ET

The Kremlin's Council of Ministers formed Lukoil in November 1991, just weeks before the USSR collapsed. The company combined three of the largest fields of the Soviet industry - Langepas, Urai, and Kogalym - as well as several refineries. (Its name derives from the first letter of each field.) Alekperov, stepping down from his evaporating job as acting Soviet oil minister, became its president.

At first Lukoil remained the property of the state. But in 1993 it was "privatized," and ownership vouchers were distributed to Lukoil employees, among others. It wasn't until 2002, when the company began trading on the London Stock Exchange, that Alekperov disclosed he owned a 10% stake. (No one is really sure how he accumulated it.) Today he holds 20%.

Almost two decades later, Alekperov, who was said last year to be worth more than $10 billion, is one of the few oligarchs still in business. How did he stay in control of Lukoil when other ambitious Russian CEOs found themselves in jail? One clue is his office. It's large, but sparsely furnished with understated red and white leather chairs. (Red and white are the official corporate colors.) Behind his glass desk is the double-headed eagle, which is Russia's coat of arms, and photos of Medvedev and Putin. Replace the eagle with a hammer and sickle and substitute a photograph of Nikita Khrushchev, and you could be back in the USSR. "We are first and foremost a Russian company," he says. "I am very thankful to both the president and the prime minister. They provide great support to our business."

They also seem to look the other way at the company's penchant for self-dealing. It is well known in Russia that the company's senior management owns many of Lukoil's suppliers and contractors. But sometimes the self-dealing seems obvious. Last March, Lukoil bought 30% of the TGK-8 utility from IFD Kapital for $1 billion. In November, Lukoil acquired an 82% interest in another Russian power company, South Generation, from IFD Kapital, for an estimated $2.8 billion. IFD's majority owners are Alekperov and Leonid Fedun, a Lukoil vice president.

Asked about allegations of corruption at Lukoil, Alekperov told me "everything the company does is transparent." He added, "But this is Russia. And in Russia there is a problem called corruption. We are trying to create obstacles to corruption. In Russia, our company is the least corrupted. Of course, I am not going to say that we are not corrupted at all, but we know these problems and we fight them."

A sea of steel

From Moscow, the 1,000-mile journey north to Russia's newest oilfield requires two Aeroflot flights and a ride on a Soviet-era cargo helicopter with dangling cables, rusty benches, and a survival kit consisting of a shovel, a ladder, and a pair of wooden skis. About an hour into the rattling, vibrating, chilly hop, the pilot banks left. It's early November, well inside the Arctic Circle, and at 1 p.m. the sun is already beginning to set. But outside the fogged-up windows, the rivers of snow that crisscross the barren Russian tundra blend into a sea of steel.

The chopper slams down on a gravel pad near what looks like a metal scrap yard. In the distance small armies of oilmen bundled in thick black coats are welding and bolting and banging on the snow-covered facility's tangled web of gleaming pipes, drilling derricks, and fire-spewing towers. It's 2F outside, warm for this time of year. Thousands of feet below the frozen earth are some of Russia's most promising oil and gas reserves: the Yuzhno Khylchuyu field, on the northern edge of the Timan Pechora petroleum basin, a New Mexico-sized triangle of land located below the Barents Sea and just west of Siberia.

While Soviet geologists discovered hydrocarbons here back in 1981, nothing started flowing at Yuzhno Khylchuyu until last June. Vladimir Tsoj, an oval-faced man with an unbreakable frown, is the project's deputy director in charge of thermoengineering. "We're developing this whole facility from scratch," he says through a translator, "and in this country that is not normal." That's an understatement. This project is one of Russia's first new major oilfields since the days of Leonid Brezhnev.

But the very things that make Lukoil work in Russia are holding it back in the rest of the world: Lukoil remains a very Russian company, with all that has come to imply, from its complex structure and opaque finances to its inefficiency and dependence on the good will of the Kremlin. And while it buys up assets in the West to gain favor with investors, it also uses its Eastern connections to enter countries like Venezuela and the former Soviet republics, where other oil companies generally aren't allowed for political reasons. Alekperov says Lukoil will double its oil and gas production outside Russia by 2010, and expects international wells to generate 20% of the company's production by 2014, up from 5% currently.

But when oil dropped below $70 a barrel, Lukoil began losing money. While changes in Russia's export tariffs allowed the company to make a small profit in January, with oil at $45, capital expenditures like new exploration and expanded production must be cut or delayed. Because the majority of its oil comes from aging fields in western Siberia, the company needs to spend more each year on expensive, enhanced oil-recovery methods just to keep production in those fields stable. Lower oil prices also dampen the company's ability to explore for Russia's undiscovered oil, most of which is located in inhospitable places like Yuzhno Khylchuyu. "But if Lukoil doesn't invest enough at home," says Jonathan Perlman, an analyst at IHS Herold, a Houston-based energy-consulting firm, "when global oil prices rebound, they might not be able to capitalize on higher prices."

While there are rumors that Lukoil has delayed paying some of its contractors - something the company denies - Alekperov says he doesn't plan to lay off any employees. He also seems to be continuing an international spending spree. Lukoil recently acquired a $1.8 billion stake in Italian refiner ERG and is reportedly interested in buying a $13.5 billion share of Spanish refiner Repsol. But Alexander Burgansky, an analyst at Moscow's Renaissance Capital, worries that the company's bond rating could go into junk territory if the company keeps buying assets. In early December, Standard & Poor's lowered the company's credit rating from positive to stable. "They will have to forget about their global ambitions for a while," Burgansky says. "They don't have the skills or the funding at the moment to do it. Priority No. 1 should be managing their operations in Russia."

But that hasn't stopped Alekperov from exploring abroad. He recently traveled with President Medvedev to Venezuela, and plans more trips soon to evaluate other potential investment opportunities. And he still insists his company will soon be the biggest producer in the world. "The most important thing is that we have an objective," he says. "If there were no goals, then what would we do?"

If Lukoil survives the downturn, Alekperov will certainly enjoy the image of Americans going to Russian-owned gas stations to fill up their government-subsidized GM cars. And that is how the world turns.  To top of page


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