Analysis: Sibneft, Slavneft, Surgutnetftegaz.
One almost needs a scorecard to follow the Russian oil industry these days. According to current talk, that scorecard may soon include Royal Dutch Shell, ExxonMobil, or maybe TotalFinaElf.
The Russian business publication Vedomosti carried word last week that Royal Dutch Shell was a suitor for a minority interest in privately held Sibneft, Russia's fourth largest oil company. That news item was picked up quickly by global business wire services and prompted a brief rally for high-flying energy companies on the Russian stock index. While both companies, Shell and Sibneft, decline comment on the subject, the story has taken on a life of its own.
The speculation is the latest example of a regional industry undergoing rapid transformation.
It hardly seems as though 90 days have passed since BP startled the financial world by investing $6.5 billion in TNK, the Russian oil company. But here is where the scorecard comes in. Before BP garnered financial headlines in January, news from Russia swirled around the strange deal that enabled TNK and Sibneft to purchase the Russian government's 75 percent interest in Slavneft, the last of the large state-owned oil entities (not counting Transneft, the government owned pipeline).
In the days leading up to the December Slavneft auction, the event was heralded as final proof that the Russian oil industry was entering a period of transparency and professionalism. The Slavneft auction represented the largest privatization in post-Cold War Russian history. It relied on Western marketing methods including bankers, a roadshow, and an open auction in contrast to previous privatization efforts, which were inevitably characterized by insider shenanigans.
But the Slavneft deal took a strange twist in the end. The largest Russian oil companies withdrew early. While seven companies initially expressed interest in bidding, four suitors were disqualified in the courts the evening before the sale. Then it looked as though the Chinese National Petroleum Company was a darkhorse contender since the Chinese government-owned company had ample cash on hand.
The Russians are as patriotic about their national assets as any citizens. CNPC withdrew from bidding the morning of the auction when it appeared several Slavneft-controlled subsidiaries had been removed from the books.
That left competition to three qualifiers, including Sibneft, Ontifor, an obscure group represented by two previously unknown women, and TNK, which ultimately did not enter a bid. The government's Slavneft stake, which includes oil production, a refinery, and gas stations, was quickly sold for $1.86 billion, barely above the $1.7 billion minimum and well under reported valuations in the $2.2 to $3 billion range.
As it turns out, Ontifor was a shell company backed financially by TNK, the firm in which BP eventually invested. More significant from the sale standpoint, Sibneft and TNK immediately announced a partnership arrangement over Slavneft assets following the sale. TNK owned 12 percent of Slavneft, or about half of the non-government stake. Last month, the two did some asset swaps and basically split ownership of Slavneft equally.
So why would Shell, ExxonMobil, or TotalFinaElf want in on this? Part of the answer is the Russian government's formal announcement last month that it intends to forego Production Sharing Agreements in future licensing rounds. PSAs are a preferred method of doing business for Western firms. The legislative and tax reforms necessary to make them a reality have been unpopular in the Russian parliament. When the Russian government said "nyet" to the PSA concept, it left investment in Russian energy companies as the major method for playing the Russian oilpatch with its substantial undeveloped reserves.
Sibneft, for example, produces more than 500,000 barrels (bbls) daily, and plans to grow volumes up to 25 percent this year, a growth profile that Western companies can only envy.
Of course, rumored deals like Shell/Sibneft are persistent in the Russian oilpatch. The Vedomosti article that broke the news also listed ExxonMobil and TotalFinaElf among those interested in purchasing up to 51 percent of the Russian company. An investment of that size has been valued at up to $9 billion, depending on the observer, or about 45 percent more than what BP invested in its TNK joint venture.
The rumors further confirm the unfolding business model in Russia. This model involves investment in Russian energy firms who hold licenses for production, generally in partnership arrangements with a Russian operating company. Russian firms like Western capital and technology. Western firms want access to Russian reserves.
Apparently the model is scalable.
Take a look at Denver-based Teton Petroleum Company, which has operated under this same model since 1997. The company is developing the Eguyak license in the western Siberian oilfields a short drive north of BP's recent investment in TNK's Samotlor Field, the world's seventh largest. If you believe in trendology, Teton is in great shape. The Denver-based company's 25-year production license is also close to three bbbls of reserves under exploitation by Occidental Petroleum.
Russian ventures require patience. After seven years, Teton appears to be reaching a milestone. The company spent $14 million to complete a 25-mile pipeline in 2001 connecting its production to a trunk line, which can ferry petroleum to Europe. The pipeline enables Teton to produce oil for export year round. The company has been drilling four or five wells annually over the last three years using Russian rigs and crews with Western completion technology. It boasts a 100 percent success rate and plans five more wells this year.
Teton's portion of the joint venture saw production grow nearly 400 percent last year to 1,750 bblso/d. The expanded production helped the company reduce lifting costs from $4.27 per barrel to $2.35. Teton is currently involved in a capital program to build or purchase additional infrastructure to further reduce lifting costs in 2003.
The Russian partner and Teton split proceeds on a 75/25 basis, though Teton holds 90 percent of the export license after renegotiating the joint venture arrangement last November. The change could boost Teton's revenues from the $7 million net realization last year to more than $12 million this year, based on an estimated average price of $20 per barrel. It has generated enough operating income to retire initial debt, though the program requires additional capital to realize its potential. Consequently, the company filed an application in January seeking listing on the American Stock Exchange, which it hopes to have in place by yearend 2003.
Teton represents the reality of operating in Russia. It has access to quality reserves--potentially up to 70 mmbbls--that it can move into the export market. It is building the infrastructure necessary to expand production. It has developed a successful working partnership in the Russian oilpatch. Much of the initial hard work is behind it.
The company intends to turn its attention over the next two years to the ultimate challenge facing Western firms in Russia. And that is to produce a profit.
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