Lukoil, Russia’s Next Oil Superpower?

Russian oil giant Lukoil believes it can transform itself over the next decade into one of the world's largest fully integrated energy companies with an enormous retail presence across the U.S. and refining capabilities and oil reserves that extend far beyond Russia.

Lukoil's senior executives believe all this can be accomplished largely with cash it will generate from its operations, development of vast fields in western Siberia and oil reserves it is purchasing abroad in Venezuela.  How much cash ranges between $72 billion and $112 billion, depending on crude oil prices.

As the price of crude has jumped over the last two years, Lukoil's investments have expanded, including construction of a year-round, ice-free, deep-water oil port in Murmansk that can handle very large crude carrier tankers; a massive oil discovery in the Caspian with an estimated 1.6 billion barrels of crude; and exploration in some of the most remote reaches of eastern Siberia.  In an interview with Forbes.com, Lukoil founder and president Vagit Alekperov said the final stage of the company's development would transform it into a multinational company. "We will be one of the largest players in the energy [industry] among private-sector companies," said Alekperov. "

American consumers might notice the change themselves as some 2,000 Lukoil gas stations appear on street corners across the eastern U.S. and possibly further afield, with the company distributing some 2.5 billion gallons of gasoline each year.  ConocoPhillips which owns 20% of the Russian company, will rebrand the final group of Mobil stations it bought under a government-ordered divesture after the Exxon Mobil merger, as Lukoil facilities by Jan. 1, Alekperov said.

A crucial element in Lukoil's attempt to go fully vertical is to have refining capacity outside of Russia, says Alekperov.  In the U.S., "the margin of refinement is so lucrative, and so profitable," he says, "it is worthwhile. ... When the whole chain of production is at home, so to speak, it is more interesting from an economic standpoint." Rather than build facilities here, he would sign joint-venture deals.  "We are getting ready to cement a large project, a venture with the government of Venezuela for development of a field in Venezuela."  Likely candidates in the U.S., however, remain sparse, especially since Alekperov himself thinks they're too pricey.  Still, having the ability to get U.S. margins for his low-margin crude makes economic sense.

Even if oil prices remained constant, the company should see substantial revenue growth as it plans to double its output of oil and gas from the present equivalent of 2 million barrels a day in the next decade.  Some of that increase will be in the form of natural gas output, which will jump from 6% of the company's total production to 33%, mostly by drilling in the vast gas fields it owns in the north of Russia.  Lukoil will continue to sell gas directly to Gazprom, which it says is a reliable and stable customer--and has an export monopoly on all Russian gas.  Still, at the company's earnings presentation on Wednesday, details were thin on how the company would be able to wring out such impressive growth.  "Considering that 80% of the company's business is in oil, it was disappointing that it didn't give more information about that," says Alex Brooks, an energy analyst in London with UBS.  Nevertheless, Lukoil remains vastly profitable.  Its latest earnings report, released Tuesday, showed a 65% growth in second-quarter profits, to $2.32 billion, from $1.41 billion a year earlier.  Despite its optimism and great ambition, Lukoil is still vulnerable to the Russian government. It is entirely in private hands.  Yet the company’s ten-year plan appears to be part of a broader Kremlin strategy to remake the Russian private sector along with other giants like Rosneft and Gazprom (which both have government equity holdings).  President Vladimir Putin seems to be attempting to make Russia a world economic force using Western capital and expertise while retaining close control over its resources.  Putin seems to envision an economy in which enormous state-owned companies and investor-owned firms can coexist peacefully.

Many investors, however, remain skeptical that in the face of greater government intrusion, Lukoil can retain its independence as a totally investor-owned corporation.  The specter of the Russian seizure of the other large independent oil company, Yukos, still hangs over the industry.  Indeed, recently, Moscow bureaucrats floated ominous suggestions that all of Lukoil's licenses would be examined for tax and natural resources violations.  Alekperov suggests that these are just bureaucrats gone wild. "It is really unfortunate that some of the bureaucrats are bringing these day to day activities to the public eye, so to speak," he says thinly. "It does have a negative effect."  Yukos was effectively bankrupted by multibillion-dollar back tax claims from the Kremlin.  But senior Lukoil executives pointed out that their company not only pays all taxes, but throws in an extra 2% to 3% "just for good measure."

Alekperov seems to believe that his own background will continue to protect the company he has led since its inception 15 years ago.  Alekperov headed all oil production under the Soviet Union when Communists were in the Kremlin.  "The foundation we created all these years," he concludes, "and the level of political comfort that I assure to the Russian government, the way they see me, makes me confident that what happened to Yukos is not going to happen to us."