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A Russian oil giant

Print edition : Jun 06, 2003 T+T-

The merger of two leading Russian oil companies to create an oil conglomerate, YukosSibneft, frustrates attempts by Western oil majors to gain a foothold in Russia and ensures that the country's oil reserves remain in Russian hands.

in Moscow

Russia seems to have created corporate history of sorts. Beating international oil majors for control over its frozen and largely uncharted oil reserves, the two leading oil firms of the country, Yukos and Sibneft, merged on April 22 creating the first Russian oil powerhouse. The development threatens to disturb the delicate balance among international oil companies. The $15-billion deal, brokered by the dynamic Yukos chief executive officer (CEO) Mikhail Khodorovsky and his Sibneft counterpart Eugene Shvindler, is by far the largest in Russian corporate history. This deal gives Yukos entry into the exclusive club of global oil majors such as British Petroleum (BP), ChevronTexaco and TotalFinaElf.

The assets of the new company are of monolithic proportions. With 19.4 billion barrels of oil and gas equivalent, it owns the second-largest oil and gas reserves in the world after ExxonMobil. The company will be the fourth largest in terms of production, pumping 2.3 million barrels of crude a day. The company will have an estimated value of nearly $36 billion. YukosSibneft is simply too big for global equity investors to ignore. It draws world-wide attention to upcoming Russian oil companies, which have the potential to give tough competition to Western oil majors.

Khodorovsky announced at a low-key press conference in Moscow that "the new industrial giant with its huge industrial and financial potential will become even more efficient, moving closer to our strategic goal of becoming a leader of the global energy market". He stressed that the merger between the two fastest-growing domestic oil companies would create "a new powerhouse that could tackle some of the most convoluted projects in Russia, such as tapping new oilfields in eastern Siberia and on the Caspian Sea shelf".

The exact terms of the deal have not yet been released and the entire cash and stock details could take a year to be completed. However, informed sources suggest that Sibneft's core shareholders (who own an 87 per cent stake in the company) will get $3 billion in cash for 20 per cent of the firm. The remaining 67 per cent will be swapped for shares in the new company at a ratio of 0.36125 per cent for every 1 per cent of Sibneft stock. This would provide Sibneft's core shareholders with a minority stake of 26 per cent in the new company. Yukos will control the larger 71 per cent stake. Khodorovsky is himself the largest shareholder and reputedly holds 36 per cent of the shares. The remaining stake will go to minority investors, who have been promised a "fair offer" after consultations with an internationally recognised bank. However, Western analysts feel that despite the fact that Russia now boasts an oil company that is global in scale, the conglomerate is not yet one that is global in value.

The greatest challenge for Yukos is going to be the development of assets abroad - the building of meaningful stakes in foreign oilfields. Consolidating in Siberia alone is not going to be enough; to get over the "Russian discount" and to increase its value, YukosSibneft will have to break into foreign oilfields. In this regard the new power house may need to play with its assets carefully and capitalise on the keenness of Western oil majors for a share in Russia's oil reserves. With the merger, the ambitions of Western conglomerates with regard to Russia have been largely frustrated, and, perhaps Khodorovsky could open the door by offering asset swaps or meaningful partnerships. This could open locked doors for the Russian conglomerate abroad, possibly in Iraq or West Africa.

Perhaps the impetus for the merger was provided by the desire of Western oil majors to gain a foothold in Russia. This January, BP, the British oil major, bought a 50 per cent stake in the Russian company Tyumen Oil Company (TNK). It paid TNK approximately $6.75 billion to combine the assets of the two companies and split ownership evenly. This deal happened despite BP's previous estrangement with TNK, which had resulted in the two companies going into litigation against each other.

Yukos and Sibneft were clearly the two other major players in the field with market capitalisations of $25 billion and $10 billion respectively. It was also common knowledge that Sibneft, with its modern corporate style of working and terrific returns, was up for sale if the price was right. Industry insiders suggest that after TNK's deal with BP, talks were under way between Sibneft and both Shell and TotalFinalElf for a 50 per cent stake in the company. Informed sources point out that Khodorovsky intervened to keep Russian oil reserves within Russia and Sibneft fell in line. It is rumoured that the Russian government was also in favour of keeping the country's oil reserves in Russian hands. This fact may have helped Sibneft's merger with Yukos.

Representatives of the Russian government were quick to welcome the merger. Prime Minister Mikhail Kasyanov praised the deal, saying: "Consolidation of such companies will surely result in higher competitiveness of Russia in the world oil market. It is an important and positive event." Finance Minister Aleksei Kudrin also favoured the merger. He said that "it was an example of how the private sector can attain positive results".

The principal negotiations between Yukos and Sibneft were essentially conducted between Khodorovsky and the dominant Sibneft shareholder Roman Abramovich. Hoping not to be out-done by Western oil majors, Khodorovsky moved fast and proposed the out-and-out purchase of Sibneft with a massive cash down payment and shares in the combined company. Citigroup was brought in to advise on valuations. Abramovich, who is also the Governor of Russia's far-eastern Chukotka region, will receive under the deal a cash down payment of $3 billion for a 20 per cent stake. Some analysts feel that the deal may have been worked out in order to sanction large cash pay-offs to core shareholders of the company before an expected drop in global oil prices in the wake of the Iraq war took place and also to provide the much-needed liquidity for the upcoming parliamentary and presidential elections in Russia.

The fact remains that the path has been cleared for YukosSibneft to expand massively into the oil reserves of eastern Siberia, where Yukos' ambitions were frustrated by state-owned companies Gazprom and Rosneft. The Russian conglomerate now possesses the needed synergies to tap into international loans required to fund such an expansion.

Government policy may also be coming out in support of the combined company. Energy Minister Igor Yusufov made a key announcement last week that for the first time the government had decided to allow private involvement in pipelines for the export of crude oil as long as other forms of State control could be maintained. The decision will help the proposed Yukos pipeline project to China, which had been blocked by the government earlier. This gives the combined company an opportunity to diversify and find a way to break into the global market. If YukosSibneft gets sanction for the pipeline project, the first step to increasing its value would have automatically taken place.

This is the second attempt to merge the two companies. The first happened in 1998 when Khodorovsky and the founder of Sibneft, the notorious tycoon Boris Berezovsky, made an unsuccessful attempt, which left behind a lot of bitterness. However, following that the two companies went in for drastic reform strategies. They were assisted by the U.S. oil services giant Schlumberger, which was brought in to help boost production and simultaneously cut costs. Schlumberger also helped introduce modern, streamlined corporate governance practices in the two companies, which allowed Yukos and Sibneft to emerge as the most promising domestic oil companies in Russia. With the merger, the process has come full circle. The conglomerate faces its greatest challenge in trying to transform itself from a company that is global in scale to one that is global in value.

With the downfall of the Soviet Union and with Russia's struggle to emerge as a sound market economy, oil is the one resource that can give Russia the economic sustenance and soundness it so desperately needs. Russia's largely uncharted oil reserves are the stuff of corporate legend - the outdated Soviet estimates put them at 48 billion barrels. However, analysts suggest that the real figure may be between 100 and 150 billion barrels. A survey of Russia's largely frozen Siberian landmass and enormous offshore Arctic sea zones poses a tremendous challenge since that would entail massive technical, economic and climatic difficulties. Further, extraction of oil from these regions is likely to be an economic and logistical nightmare.

Today, YukosSibneft is well-placed. Its combined assets and massive capacities allow it access to large international loans, which could go far in developing the oil industry in Siberia. However, it remains to be seen if the company can garner government support to export its product.

For a long time, the Russian government has blocked private involvement in pipeline projects, which remain under the control of Transneft, the agency that manages the country's pipelines. Perhaps the freshly merged company will be able to sort out this problem. Already, the government has hinted that it will give the conglomerate the go-ahead on its proposed pipeline to China.

If YukosSibneft manages to capitalise on Russia's oil reserves in Eastern Siberia and its offshore reserves in the Arctic Sea, it will become the mammoth oil conglomerate from the Tundra that it promises to be. This transformation would require imaginative and targeted surveys, state-of-the- art extraction mechanisms and a breakthrough in Russian oil export. This is the challenge that stares YukosSibneft in the face. This development can provide it with the value-addition it needs to challenge established Western oil majors. If the new company is unsuccessful in this endeavour, the merger would just be another well-planned and timely payoff deal among core shareholders. Only time will tell.