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THE WALL STREET JOURNAL: Exit Yukos, Enter Conoco? “For oil multinationals eager to invest in Russia the lesson to be learned from the Yukos case is indeed a simple one: Stay out of politics and on the right side of the Kremlin -- and be sure to pay your taxes on time.” ( 12 Nov 04



November 12, 2004


By now it should be apparent to anyone who has the slightest grasp of the Yukos saga in Russia that the company's former CEO (and still its largest shareholder) Mikhail Khodorkovsky and his partner Platon Lebedev will be found guilty -- or that they will face at least a few years in prison when their almost year-long trial ends. What started as a mere accusation of fraud and tax evasion -- an accusation with obvious political motives -- eventually turned into a wholesale battle for power and dominance between the group of oligarchs who control Russia's key industries and power ministries headed by President Vladimir Putin's closest allies and advisers, the so-called siloviki, eager to reassert their influence.


Yukos, Russia's biggest oil company until a few months ago and the most preferred Russian stock abroad -- mainly for its impressive performance, according to equity analysts -- is now under enormous pressure from the government to pay a total of about $14 billion in back taxes starting from the year 2000. Although Yukos continues to pump about 1.7 million bpd of oil, most of its bank accounts were frozen in early July and the rest in early September. Its largest subsidiary, Yuganskneftegaz, is soon to be put up for to auction, which, company spokesmen said, endangered its ability to pay salaries and maintain operations.


They were right. As reported in late September, one of Yukos's major clients, the Chinese National Petroleum Company (CNPC) refused to pay its import bill, as it was unsure about Yukos's ability to supply crude to the Chinese border. The situation has put the Yukos into a predicament and today it faces a real possibility of bankruptcy.


Probably the main reason for freezing the bank accounts is to prevent any members of Group Menatep -- the entity headed by Mr. Khodorkovsky and his partners, which owns a controlling 44% stake in Yukos -- from drawing off cash from the company prior to a bankruptcy. If there is a tax payment deal struck with the company this would definitely boost the value of its shares, benefiting Mr. Khodorkovsky in the first place. Therefore it would be logical to assume that the pressure on Yukos is there to stay unless these men give up their stakes and comply in full with the government's tax requirements.


The coming days are of critical importance for local and foreign investors and financial institutions such as Citigroup and France's Societe Generale -- those two organized a loan syndicate that raised $2.6 billion for Yukos at the beginning of last year before the attacks on the company started -- and for the Russian economy in general. The most negative outcome for the Russian economy would be a Yukos bankruptcy. In such a situation, it would be harder for other Russian companies to raise money abroad. And that would be devastating, not only for shareholders or lenders like Citigroup but also for oil consumers who are counting on rising Russian oil production to counter the recent surge in crude prices world wide. Mr. Putin has repeatedly stated, though, that it is not in government's interest for the company to go bankrupt.


For oil multinationals eager to invest in Russia the lesson to be learned from the Yukos case is indeed a simple one: Stay out of politics and on the right side of the Kremlin -- and be sure to pay your taxes on time.


On Sept. 29, America's ConocoPhillips confirmed that it is the brightest student of all on this subject. As expected, the company struck a deal that day to buy Russian government's remaining 7.59% shares in the oil giant, and the Kremlin's favorite, Lukoil, for a total of $1.988 billion. This was the biggest show of support for Russia by a Western company since the Yukos affair began, allowing Mr. Putin to minimize the political and legal risk factor that have alarmed investors watching the Yukos affair.


The deal also gives Lukoil a chance to re-enter Iraq and to supply crude to Conoco's East Coast refineries in the U.S., which Lukoil has been eying for a long time now. Mr. Putin is also happy because the deal gives him one less problem as he focuses on the rising threat of terrorism inside Russia.


Even before the Conoco-Lukoil agreement -- with oil prices spiking and new oil fields scarce -- the global oil companies were looking hungrily at Russia. Neither the Yukos debacle nor gruesome acts of terrorism seem to have hurt their appetite for the black gold. Although current talk is about investment plans, and other multinationals have not invested significant amounts since the Yukos case began, it seems we will not have to wait for long to see some of those plans turn into actions.


Thus TNK-BP (An Anglo-Russian joint venture for which BP paid $8 billion last year) plans to invest an additional $1.4 billion on upgrades and exploration this year and at least $1 billion a year over five years. According to Robert Dudley, CEO of TNK-BP, the deal has been profitable and the gross dividends from the venture this year will exceed $2 billion. The same kind of drive and activism is seen on the part of Shell , Exxon and Total.


Russia does offer some indispensible advantages to its investors. Not only does it have the largest reserves of natural gas in the world; it may actually contain larger reserves of crude than standard calculations suggest. United Financial Group, a Moscow-based investment bank, estimates that eastern Siberian reserves, the next oil frontier according to some analysts, could be as much as 51 billion barrels. That is why interest is shifting precisely in that direction, although most of the production is still concentrated in western Siberia.


Then comes the fact that Russia's reserves are cheap, in terms of acquisition costs and extraction costs, in comparison with average figures in the West. Extraction costs, for instance, are $2 per barrel vs. $1 in Saudi Arabia and a global average of $4 to $5 per barrel. The probability of drilling a dry well is low thanks to surveys, which have revealed where much of the oil is; and most Russian oil is onshore.


Another factor of attraction is that Siberia borders China -- the second-largest consumer of oil in the world -- and the economies of eastern Asia. These are the markets that are going to drive the global demand for oil in the next couple of decades. Meanwhile, as Mr. Putin's latest visit to China and discussions held with Chinese authorities hint, the government is likely to give a go-ahead to the building of a $10 billion pipeline to the Far East, and that would further boost Russia's export potential in those key regions.


Certainly, it is these advantages that give the Russian government leverage in trying to attract Western capital and expertise. This even as it maintains control over the domestic oil industry directly and indirectly; for instance, as seen in the possible merger of Rosneft with Gazprom -- the two largest companies controlled by the government -- in order to form an energy giant on a global scale.


Mr. Putin and his advisers appear to have calculated that despite the added dimension of navigating the worlds of politics and diplomacy that are an unavoidable aspect of doing Big Oil business in Russia, investors will still go where the big oil is. And they may be partially right that the destination is bound to be Russia. However, the Kremlin must also accept that it will have to put commercial considerations before political ones if it wishes to maintain the dynamism of the sector. After all, that dynamism is the largely the product of the drive and activities of private companies, both foreign and domestic.


Mr. Huseyinov is an independent political and economic consultant on international energy issues and emerging markets of Eastern Europe and Russia, based in Ankara.

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