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Russia Profile
October 5, 2009
A Refined Approach to Oil
Russian Oil Companies Are the Weak Link in the Kremlin’s Plans to Expand Its Grip on Downstream Assets Abroad

By Graham Stack

It is official Russian policy to push oil companies to acquire downstream assets outside of Russia, and with a wave of mergers and acquisitions set to sweep European refineries, opportunities are looming. But European governments are not enthusiastic – and neither are many Russian companies.

Igor Sechin, the chief “silovik” in former president Vladimir Putin’s Kremlin, now deputy prime minister for the energy sector in prime minister Putin’s government, revealed his dream to the Wall Street Journal earlier this year – a rather modest plan for the man who is believed to have masterminded the dismantling of Mikhail Khodorkovsky’s Yukos. “My dream is for Russian oil to be refined in Russia or by assets controlled by Russian companies,” he confided.

Sechin’s plan might be close to realization, as analysts agree the European oil product market is facing a wave of mergers and acquisitions (M&A). According to Jürgen Doetsch, co-owner of German oil trader Erich Doetsch, “the European downstream market is facing a structural shift. The golden decade when refineries in Europe earned big money is ending, and refineries could return to being loss-makers as they were for 25 years before the turn of the century.”

The shift is marked by the big six super majors, such as British-Dutch Shell, French Total S.A and U.S. ConocoPhilips, divesting or considering divesting refineries. Shell is looking to sell one UK and two north-German refineries, and ConocoPhilips is uncertain about the future of its Wilmershaven refinery in Germany.

Total S.A. CEO Christophe de Margerie specified on September 22 that Russian companies could be among the buyers: “they have a market to develop in Europe and may be interested to buy when we are interested to sell,” he told Bloomberg. His statement followed hot on the heels of Total’s sale of a 45 percent stake in its Dutch Vlissingen refinery to Russia’s Lukoil in June for $725 million.

The selling is not just limited to the multinationals. Polish petrochemical national champion PKN Orlen, owner of Europe’s largest chain of filling stations, is said to be looking to divest a 63 percent stake in Czech Unipetrol and an 87 percent stake in Lithuania’s Mazeikiu Nafta in order to pay off $3.2 billion worth of debt.

Governments are also getting in on the act. The Belarusian government is mulling privatization of its strategically significant Naftan-Polymir refinery complex, the country’s largest, supplied by the Druzhba pipeline. Belarus has been in talks with Russian majors Rosneft and Lukoil over a sale, but is dragging its heels. “If you have money and willingness, then please come. I am ready to support the program of privatizing the Belarusian oil-refining association,” Belarusian President Alexander Lukashenko said on September 16, evaluating the total complex at nearly $3 billion.

Another dark horse is Venezuelan President Hugo Chaves and the Venezuelan national oil company PDVSA. PDVSA owns stakes in a number of German refineries as partner in Ruhr Oel, a joint venture with BP that controls around a quarter of German refinery capacity. Ever since coming to power in 1999, Chavez has said he will divest PDVSA’s overseas assets and in 2003, PDVSA was in talks to sell to Russia’s Alfa Group, co-owner of oil company TNK-BP, but these talks came to nothing.

September, however, also saw the signing of an upstream tie-up between a consortium of Russian oil companies and PDVSA to extract in Venezuala’s Orinoco regions. The partnership could plausibly entail asset swaps, seeing transfer of Venezuela’s downstream stakes in Europe to Russian companies.

Pipeline pressure

Russian companies, however, face considerable political resistance to plans to buy into European refineries, especially those of strategic significance. Analysts expect the ongoing M&A wave to trigger a number of political spats between Russia and individual European countries.

Leonid Fedun, the vice president of Lukoil, Russia's second biggest oil company and most active acquirer of foreign assets, complained to the Financial Times in April that "some countries in Eastern Europe have an extreme level of political antagonism toward Russian investments." In the same month, Russian President Dmitry Medvedev complained of “idiotic” fears in Spain of Russian investment in the energy sector.

Fedun's comments came a week after the privately-owned Russian oil company Surgutneftegaz acquired 21 percent in the Hungarian energy group MOL. Hungarian politicians responded in a dramatic fashion: the Hungarian courts allowed MOL to delay registering the new shareholder until poison-pill clauses had been adopted in the company’s charter that left decision-making power with the government-backed board of directors at the expense of shareholders.

Such tactics may however cause the Kremlin to up the ante rather than back off. Russia has gained bargaining power vis-à-vis the Central European refining sector supplied by the Druzhba pipeline, following the start of construction in August 2009 of the Baltic Transport System-2. BTS-2 will reroute Russian oil from Druzhba around Belarus to Russia’s new Baltic port of Ust-Luga in the Leningrad Region, and thus increase flexibility of export routes. Refiners remember that Lithuanian refinery Mazeikiu had its oil supply shut off by Russian pipeline operator Transneft after it fell into Polish, rather than Russian, hands in 2007.

The East Central European countries put their hopes on the Odessa-Brody pipeline running through Ukraine from the Black Sea, planning to extend it to the Polish refinery of Plock, Orlen’s biggest plant. The pipeline would then ship Azeri oil to Central Europe. However, the feasibility of the plan is not yet established, and the pipeline continues to be used in reverse mode to ship Russian oil to the Black Sea.

Reluctant imperialists

The weak link in the Kremlin’s strategy could be the Russian oil companies themselves. With the noticeable exception of Lukoil they have shown little interest in expensive acquisitions in Europe’s downstream sector.

Lukoil is open about pursuing downstream expansion, with major acquisitions in Italy in 2008 along with the Dutch acquisition from Total this year. However, Lukoil’s ambitions predate Igor Sechin’s watch over Russia’s energy sector. In fact, the fully private company, in which U.S. major ConocoPhilips holds a 20 percent stake, counts as one of the freest from Kremlin influence. And the company’s strategy of overseas downstream expansion was evident as early as the 1990s, when it purchased a chain of filling stations in the United States.

On the other hand, the state-owned Rosneft, Russia’s largest oil company, has still to make a large foreign acquisition, and is focused on capital-intensive upstream expansion in the Arctic and Pacific shelf, with little resources left for acquisition abroad. Gazpromneft, the oil division of state-controlled gas giant Gazprom “doesn’t really have the scale for European acquisitions to make much sense,” according to Ron Smith, head of research at Alfa Capital.

Surgutneftegaz, the opaque private oil company that bought 21 percent in MOL in April, would seem the most likely acquirer of European assets. The company, generously described by Sechin as “Russia’s best privately-run oil company,” is believed to be sitting on a cash pile and potential war chest of $20 billion.

At the time, however, many commentators believed the acquisition of a stake in the Hungarian company was requested by the Kremlin for political reasons, namely to stymie the Nabucco gas pipeline project in which MOL is a participant, rather than being part of Surgutneftegaz strategy. “They are very tight and un-ambitious with their massive pile of money, the MOL thing notwithstanding. It would be completely out of character,” said Smith. In addition, Surgutneftegaz is more focused on downstream investment in Russia.

Finally, TNK-BP held talks with PDSVA on acquiring the Venezuelan company’s refinery stakes in 2003, but the talks ended without any results. Analysts say TNK-BP is very focused on adding value, and the returns on European refining are not sufficiently compelling. TNK-BP is more focused on Russian downstream, having just overhauled its Ryazan refinery, one of the largest in Russia.

This leaves Lukoil with a clear field in making acquisitions downstream in Europe, as far as local governments allow, and, in conjunction with the ConocoPhilips 20 percent stake, well on its way to becoming a true oil multinational.

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