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Russia's king of crude

Lukoil, the country's largest independent company, has become the face of Russian business abroad. But can it be the next Exxon?

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

The Yuzhno Khylchuyu field, 1,000 miles north of Moscow, came online in June and will soon be producing 150,000 barrels a day.
Vagit Alekperov, Lukoil's president, assembled remnants of the Soviet energy industry into a modern, vertically integrated oil giant.

(Fortune Magazine) -- There are many things that simply can't be known about Russia's largest independent company, Lukoil. How did its president come to control the oil and gas giant in the first place? How do the founders get away with buying company assets through a bank they own? And, perhaps most important, can it survive if oil prices stay as low as they are?

AN APOLOGY: Since this story was published in Fortune's Feb. 2, 2009, issue, we have discovered that several passages were lifted from "The Triumph of the Quiet Tycoon," written by Peter Maass and published in the New York Times Sunday Magazine on Aug. 1, 2004. Fortune apologizes to Mr. Maass and the New York Times Sunday Magazine.

But one thing is clear about Lukoil: It's a company that mirrors Russia right now. Back in the summer it looked as though it was on top of the world. In less than 20 years after a clever young bureaucrat put it together from the remnants of the Soviet oil industry, the company had managed to become not just a global player in petroleum but also the face of Russian business abroad. Among the world's independent oil companies it controlled the second-largest reserves, behind Exxon Mobil (XOM, Fortune 500). It had operations in more than 40 countries. Its president was the first Russian citizen to win the prestigious Woodrow Wilson Award for Corporate Citizenship. Americans did a double take when Lukoil's red and white gas stations started popping up on the East Coast a few years ago. The sight was perhaps not as jolting as a Chinese car on the New Jersey Turnpike would be, but it signaled to many - especially to the Russians themselves - the beginning of a new world order.

When the credit crisis took hold in the fall, Russians - and even some Western economists - thought it was mostly a U.S. problem. They thought the new Russia, an energy powerhouse that produces more oil than Saudi Arabia, would be spared. But when the prices of commodities, including oil, collapsed, so did Russia's economy. Economic growth, which averaged about 7% the past five years, may drop below 2% this year. Foreign capital continues to flee. The ruble is under pressure. And for the first time since the collapse of the Soviet Union in 1991, the threat of large-scale unemployment looms.

Lukoil finds itself short of cash and, some analysts fear, at risk of needing a government bailout. Its stock is down 68% since its peak last May - underperforming most of its international peers - and rumors of involuntary vacations have rippled through the company. The situation has gotten so bad that Lukoil's partner, ConocoPhillips, is expected to take a write-down as large as $10 billion on its investment in the company, analysts say.

No one doubts that oil prices will rise again - and that the spike this summer was only a foretaste of what will occur when the economy rebounds. When that happens, Lukoil may be the oil company best suited to take advantage. The reason is simple: Much of the world's remaining energy resources are located in countries off-limits to most Western oil companies.

"It's very difficult to see where Exxon or Shell or BP finds new oil in the next few years," says Mattias Westman, the founding partner of Prosperity Capital Management, a London-based hedge fund that owns $100 million of Lukoil stock. "The same cannot be said about Lukoil. They have the best chance of acquiring and developing more reserves and growing more than any other oil company on earth."

That's why Lukoil president Vagit Alekperov, a tough-minded former bureaucrat with a permanent scowl, still plans an ambitious expansion - albeit slightly toned down since the summer - and insists his company will soon be mentioned in the same breath as Exxon Mobil, Shell (RDSA), and BP (BP). The challenge, he says, will be surviving until then.

'Almost everything was perfect...'

A few minutes befoer my first meeting with Alekperov, his aide, a large older man with thick shoulders and a soldier's stride, walked up, looked me up and down, and put his face near mine. Then he started yelling in Russian. My petite translator jumped. "He says, 'No small talk,'" she translated. "'Mr. Alekperov doesn't like small talk. Do you understand? Ask your questions one after another. Do you understand? Mr. Alekperov is very important and very busy. Do you understand?'"

The aide took one step backward, turned around, and led me into a small meeting room in Lukoil's imposing glass and steel Moscow headquarters. Inside was a bronze statue of cowboys lassoing a bull, a gift from ConocoPhillips (COP, Fortune 500) CEO Jim Mulva, whose company owns 20% of Lukoil. A shelf held photos of Alekperov with President Dmitry Medvedev, Orthodox Patriarch Alexy II, and Prime Minister Vladimir Putin - Russia's holy troika.

At exactly ten the door whirred open and Alekperov entered. He is 58 years old - he was 41 when he took over Lukoil - and has short, spiky gray hair. Maybe it was the collapse of the price of oil or the meltdown in the Russian stock market, but on this day Alekperov looked extremely annoyed. "Almost everything was perfect in the whole world, and then this happened," he said through a translator. "There are these great chances to develop and acquire new assets and to expand and develop our business. But we have to be careful. We could become bankrupt as well."

Alekperov was born in Baku in Azerbaijan, then under Soviet control and the capital of its petroleum empire. He graduated from the Azerbaijan Institute of Oil and Petrochemistry and soon went to work on the Oily Rocks, a storied offshore city on the coast of the Caspian Sea. The conditions there were famously treacherous. Once, during a storm, a blowout on his drilling rig sent him flying into the high seas, and he had to swim for his life. Years later he was supervising an oilfield in remote western Siberia when a fuel pipe ruptured. His repairmen refused to go near it, fearing an explosion, and legend has it that Alekperov walked up to the pipe, sat on it, and told the men to get to work.

He wasn't just brave - he was smart. And soon the Kremlin recognized it, appointing him, at age 40, the youngest deputy oil minister in Soviet history. The timing couldn't have been better. It was 1989, and Mikhail Gorbachev was opening the door to Western investment. Oilmen from around the world flocked to Moscow, hoping for their share of the prize. (The country's proven reserves are estimated at 80 billion barrels today, according to BP, and Russia is thought to have triple that still to be discovered - another Saudi Arabia.)

While the international petro-giants were circling the imploding Soviet Union, its top bureaucrats were looking ahead to its demise. Alekperov flew around the world, taking notes from the top executives at companies like BP and ENI (E), the Italian giant. He came to believe the only way Russians could compete against Western companies was to copy their business model. That meant vertically integrating the three branches of the industry - exploration, refining, and distribution - that were strictly separate under the old Soviet system. (Alekperov's official biography is aptly titled Vertical.)

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