#6 - JRL 7061
Integrated Oil Cos Tread Lightly When Investing In Russia
February 13, 2002
By DAVID BOGOSLAW
Of DOW JONES NEWSWIRES
NEW YORK -- If BP PLC's (BP) efforts to form the third-largest oil company in Russia don't spur other integrated oil companies to follow suit, it won't be for lack of prospects to develop.
Earlier this week, the British oil giant said it would spend $6.75 billion in cash and stock to form a joint venture between Sidanco, of which it already owns 25%, and two industrial holding companies, Alfa Group and Access-Renova. The two holding companies together own TNK International, the parent company of Tyumen Oil Co. (R.TYO), Russia's fourth-largest oil producer.
Given the plentiful reserves of oil and gas in Russia and as friendly a political relationship as has ever existed between the U.S. and Russia , one would think U.S. majors would be champing at the bit to get at the largest reserves outside the Organization of Petroleum Exporting Countries.
It's not so simple - not least because of the complexities of doing business in Russia .
"BP is using its interest in Sidanco to expand in Russia ," said Fred Leuffer, an analyst at Bear Stearns & Co. "That's different than going to Russia for the very first time and making a very big investment."
Still, with international majors struggling to meet targets they've set for production, growth and returns on capital, the Russian prospects look attractive to them, said Leonid Mirzoyan, an analyst at Deutsche Bank AG in Moscow.
Although he anticipates more transactions similar to the one orchestrated this week by BP, he isn't expecting there to be a wave of them. Ultimately, it will be up to the Russian government to decide how big a chunk of Russian oil reserves it's willing to have fall into the hands of foreign players, he said.
Having grown sufficiently cash-rich over the past five years, and with access to drilling technology from oilfield service companies, Russian producers don't need capital investments from international majors except for the most capital-intensive projects, Deutsche Bank wrote in a report released last Friday. But Russian producers might benefit from the validation that an equity investment by an international player like BP can provide. "They feel they trade at too steep a discount to international oil companies' stocks," said Michael Urban, a New York analyst for Deutsche Bank. "They feel investment from BP gives them third-party validation, gives them a potential takeover premium, an M&A (merger and acquisition) premium."
Western Partners Needed For Some Projects
For Western oil producers eager to get a foot in the door, an equity investment such as the one BP is trying to expand would be quicker than the often tortuous process of negotiating a production sharing agreement, or PSA. PSAs are currently the only legal instrument by which foreign companies can protect their claims to actual reserves in the ground. But final PSA legislation, which would include a tax provision, has yet to be passed by the Duma or parliament, though it did approve an initial version of a PSA chapter of the tax code last June.
Except for a handful of PSAs that were "grandfathered" under a previous regulatory and legal regime, all agreements currently in the process of being signed will be subject to amendment once new PSA legislation is passed. That's risky for Western oil companies, analysts say.
For projects in undeveloped areas, like the offshore fields off Sakhalin Island, Russian producers are much more in need of a Western partner.
Exxon Mobil Corp. (XOM) has a grandfathered PSA to develop its 30% interest in Sakhalin I, where it expects to start production at 250,000 barrels a day in 2005. It also is involved in a PSA for Sakhalin III blocks.
"Due to the huge upfront investments and the operational, technical and other risks involved in Sakhalin I, it was critical to obtain the stability that a PSA regime offers," said Mark Boudreaux, director of government and public affairs at Exxon Mobil.
ChevronTexaco Corp. (CVX) has a 33% interest in the Kirinsky field within Sakhalin III but hasn't been able to secure a PSA to develop it, according to Deutsche Bank. But Mirzoyan believes Chevron has a good chance of getting a PSA for that field by 2005.
Chevron spokesman Fred Gorell wouldn't comment on a time frame for developing those reserves.
Last October, at a U.S.-Russia Commercial Energy Summit, a Chevron vice chairman said the company is also considering other Russian projects.
ConocoPhillips (COP) is trying to get a PSA for its Northern Territories project this year with local partner LUKoil, according to Deutsche Bank. A spokesman for ConocoPhillips wouldn't comment on the company's interest in Russia , saying the bulk of its overseas reserves are in Venezuela, the North Sea and Asia.
Pipeline capacity constraints within Russia are another concern. But a Western producer thinking of investing in Russian oil is more likely to pay attention to a Russian partner's asset base and production efficiencies, Mirzoyan said.
He expects the Russian government to decide whether to move ahead on at least two of three major pipeline projects by the middle of this year.
With or without the prodding of Western producers, Mizroyan thinks there is room for consolidation among Russian oil companies.
"To grow into real international players, the Russian oils need to increase their critical mass and their ability to fund on a grand scale in Russia and outside Russia ," he said. "But it's a lengthy process. It won't happen overnight."