Is Gazprom Going To Get Yukos?

Saudi Arabia To Increase Oil Production

Wall Street Journal: "Saudi Arabia plans to boost oil-production capacity by as much as 14%, to 12.5 million barrels a day, during the next few years. Oil Minister Ali Naimi pledged to steadily match growth in demand with output increases."

Today's Analysis: Russia's Crude Drama

Putin's winning streak has hit a rough patch. For the past year, aside from the fact that he could not talk the U.S. out of invading Iraq, Russian President Vladimir Putin, has had things go very much his way. But the election in the Ukraine, and the Yukos situation coming to a head in the next few weeks, have the potential for sending the Kremlin back to the drawing board, barring a few surprises along the way.

The Ukraine election, reportedly fraught with significant amounts of fraud, is a key development in the upcoming relations between the U.S. and Russia. The White House, and the European Union have both backed some kind of arbitration or peaceful solution to the sticky situation, while the Kremlin is still backing the … candidacy.

Whether something is going to be worked out behind the scenes that allows both the U.S. and Russia to come out as winners remains to be seen.

The net effect is that the Ukrainian election is taking up the news coverage, while the equally important story of Yukos, which could be nearing some kind of decisive climax, is not getting the mainstream coverage.

It's the second story that, in our opinion, will influence the financial markets more closely, at least in the short term.

Gazprom In The Lead For Yukos

According to multiple reports, state owned Russian natural gas behemoth Gazprom is the leading player in the hunt for the beleaguered Yukos.

As usual with Russia, nothing is certain until it's actually happened. And even then, anything is possible given the sometimes illogical and befuddling politics of the Kremlin and its ongoing war with the oligarchs.

But, if Gazprom does buy Yukos, or a major part of it, the situation for Russia, the oil markets, and the United States gets even more complex.

The Latest Developments

The Moscow Times on 11-30 reported that Deutschebank had advised Gazprom to "buy Yuganskneftegaz, Yukos' main production unit, as part of a wider strategy to increase its presence in the oil sector."

Bloomberg, followed with: "OAO Gazprom, the world's largest natural gas producer, will bid for OAO Yukos Oil Co.'s biggest oil unit next month and may buy other Russian producers to create an oil business rivaling that of Exxon Mobil Corp.'s within six years. The company's oil output would more than double to as much as 90 million tons (1.8 million barrels a day) next year if state-run Gazprom buys OAO Yuganskneftegaz when it is auctioned Dec. 19 by the government, said Sergei Bogdanchikov, the head of Gazprom's oil unit Gazpromneft. Gazprom may be producing as much as 125 million tons a year in 2010, he said."

The Analysis

Has the oil market factored in the upcoming Yukos auction? Recent reports suggest that the Kremlin is finding itself in a situation that could take several years to sort out, leaving a leading global oil producer in limbo.

Russian oil giant, and its most likely to be broken up company at the moment, Yukos, is heading for the auction block. But the situation is far from clear. And the implications for the Russian political system, the world's willingness to invest in Russia, as well as the price of oil are confusing.

Over the last year, the situation has gotten worse as each new successive turn on the screw has been wound. summarizes the Yukos saga succinctly, starting with the arrest of former Yukos CEO Mikhail Khodorkovsky. "Khodorkovsky broke the informal arrangement the Putin government made with the oligarchs when Vladimir Putin became president in 2000: You can keep the assets gleaned from the state in the 1990s so long as you pay your taxes and keep out of politics. As of early 2003, Khodorkovsky was being touted as a future president. Soon after, Putin lowered the boom. Since then the government has leaked out the bad (from the investors' viewpoint) news piecemeal in order to avoid a market run. First, one of Khodorkovsky's associates was charged with defrauding the state. Then the government slapped Yukos with tax evasion. Later, both Khodorkovsky and his associate were arrested. Then international arrest warrants went out for other associates. Then, in more than a dozen separate steps, Yukos received a series of back tax bills for years gone by that totaled more than Yukos' revenues for those years. During that period, the government froze the shares in this or that subsidiary to ensure Yukos could not sell assets at market prices to pay the debts, and then announced it would manage the sale itself. Now, the asset in question -- Yuganskneftegaz -- is being undersold to ensure that it lands in the lap of a pre-chosen company."

But the situation continues to become more strange at Yukos, as each day goes by. According to the Moscow Times over the weekend: "All six members of Yukos' senior management team have left Russia in fear of arrest and, according to people close to the company, their absence could end up affecting the company's operations, possibly endangering supplies."

According to the Times summons for the Yukos management team have been sent out, and no one is answering: '["The entire management board is away,"] Yukos chief financial officer Bruce Misamore said by telephone Thursday. ["I'm not sure where everyone is, but I'm pretty sure no one is in Moscow."] Misamore was summoned by prosecutors to appear for questioning Wednesday amid a widening probe into management activities. But the native Texan was away on business and is unsure that it is safe to return. ["I heard from somebody with good information that I could possibly be subjected to criminal charges or arrest,"] he said, adding that he had heard other ["behind-the-scenes threats"] that other top executives could face arrest. ["I would be glad to answer [prosecutors'] questions as long as I'm assured that I'm not in personal jeopardy."]'

It Gets Worse

The Times added: The company, already reeling from $20.5 billion in outstanding claims for back taxes, will be broken up Dec. 19, when its main production unit, Yuganskneftegaz, is slated for auction by the government. The starting price is $8.65 billion. However, a source close to Yukos said Thursday that Yugansk itself, which owes an additional $4 billion in taxes and penalties, will soon receive a new $1 billion tax claim for 2003. Including debts to international creditors and loan guarantees to Group Menatep, Yukos' biggest shareholder, Yugansk may owe up to $7.8 billion by the time it is sold, a debt assumption unlikely to attract bidders., citing a source within the Russian Energy Ministry, reported that "Putin prefers a Western-led firm such as TNK-BP or France's Total. In particular, Putin is holding out for Italy's ENI, in part because of his close relationship with Italian Prime Minister Silvio Berlusconi. In fact the specific auction price was chosen in order to make it cheap enough to attract Western interest, but too dear for Russia's cash-poor firms to afford."

The Moscow Times reported last week that "officials close to the company said the ongoing legal harassment, incessant searches and interrogations of company officials could end up disrupting operations." Buy November 29, Yukos CFO Misamore was raising the possibility of accidents at the company's production fields. Misamore told the Times from London: "We are doing our best to make certain the company is operating safely. But if we've got prosecutors calling people in for questioning and threatening criminal charges against managers in the field, [managers] are not going to be concentrating on preventing accidents, or directing their attention on what they ought to be doing."

Blame Shifting To Government: Danger In Siberia.

And as Yukos sinks, the spin is turning on the government, with the shifting sands moving toward production disruptions. ["The fact that people are being called in for questioning all the time is making it impossible to continue normal activity,"] said a source close to Yukos (according to reports in the Moscow Times.) ["The state is now responsible for the strain on the company's activities and there could be serious consequences, including for production. There are very dangerous production facilities,"] the source said, referring to the company's Siberia operations."

The situation at Yukos is now apparently on the verge of disorder. "Another source close to the company, speaking on condition of anonymity, said raids at Yukos headquarters in downtown Moscow and at offices in the regions are now an everyday occurrence. CEO Steven Theede's office was raided last week, he said.

And now, there are doubts about the ability of anyone other than the Russian government being able to run the company. "Even though Misamore insisted senior management could continue to run the company ["from anywhere"] in the world, others were doubtful. "[Jailed Yukos founder Mikhail] Khodorkovsky was completely justified when he absolved himself of responsibility and said the attack could affect operations ecologically and technically,"] said State Duma Deputy Alexei Kondaurov, a former KGB general and, until last year, the head of Yukos' analytical department. Khodorkovsky warned in a statement Friday that responsibility for Yukos' "very dangerous production facilities" now lay in state hands.

In fact, there is now speculation that things at Yukos could become a very loose and perhaps ineffective operation. ["Now that senior management is away, anything could happen,"] Kondaurov said. ["High-quality specialists will remain in place in the regions, but if senior management is away it will have a psychological effect on employees. Discipline will be lowered,"] he said. ["I find it difficult to imagine how such a complicated organism in such a complicated situation can be managed from abroad,"] Kondaurov said.

And there are other factors to be considered. "Analysts said the threat to Yukos' output, which accounts for about 2 percent of the world's total, should not be overlooked. ["The key issue is social stability. If the actual oilmen on the ground become worried or concerned about their future, than there could be real troubles,"] said Valery Nesterov, oil and gas analyst at Troika Dialog. ["Otherwise, Yukos is such a fine-tuned mechanism that destroying it could be a rather hard task."] Yukos spokesman Alexander Shadrin said the company was continuing to operate as usual and production levels were being maintained. Meanwhile, Misamore said management was continuing to consider whether to file for bankruptcy. ["We continue to review all options,"] he said. Declaring bankruptcy would be personally risky for Misamore and other senior executives, however, because they could face criminal charges if a Russian court were to rule that the company's assets still outweigh its liabilities."

A Failed Auction? sums it all up in three steps:

1) "The problem with Putin's plan is that the subsidiary represents about half of Yukos' business, and Yukos now has a tax bill just shy of $25 billion, with more to come. No Western firm would ever seriously consider bidding on an entity with such an outstanding -- and unresolved -- debt that was put up for auction in such a legally sketchy way."

2) In short, the auction is likely to fail outright. That means the government must have a second choice lined up. That choice will most likely be Gazprom, the state-run natural gas monopoly. The government already is in the process of consolidating its oil assets under the Gazprom banner. The problem is that Gazprom is very cash poor as it is the government's primary cash cow. Gazprom simply cannot afford $8.6 billion to pick up the subsidiary; it now has only about $2.6 billion in cash on hand.

3) Barring a possible joint bid with a Kremlin-friendly firm such as Surgutneftegaz, the next shock to the Russian market will look something like this: The Dec. 19 auction will have no qualifying bids, leading the government to declare it a failure. That same day, the government will hold a new auction with a much lower launching price, probably in the realm of $3 billion to $4 billion, and Gazprom will become the proud owner of an oil company.


The whole thing still has several days left before it actually happens, which means that several things could happen. But the pace of developments, and the single direction of the trend suggests that Gazprom will buy Yugansk. The fact that the whole thing is moving ahead also suggests that Gazprom has found outside help from one or more foreign partners, and that at some point there will be some kind of announcement.

A deal with Yukos could still be struck, although that is the least likely of all possibilities.

Several oil companies could decide to throw in their names in some kind of joint venture, and some likely already have been negotiating, to be sure. Chevron Texaco, which we own, has an interest in Russia. BP and Conoco Phillips are also already there. Total and Eni have already been mentioned, and Eni seems to have the favorite son status according to sources in multiple areas.

One big player has not been mentioned, the Carlyle Group. This is the hedge fund fronted by former GOP politicos such as Frank Carlucci and James Baker. They were initially involved in potential deals with Khodorkovsky before the whole mess developed.

It is also possible that if some deal has been struck, it could involve the possibility of some settlement or reduction of the tax bill owed by Yukos. Whether that kind of arrangement, if indeed it emerges, is seen as beneficial or as more corruption and cronyism by the markets depends to be seen.

A whole lot is riding on this deal, for Putin, for international oil majors, and for the White House, which has desperately tried to get Russian oil to the United States in larger quantities.

One thing is certain. In the helter skelter world of Russian politics, drama, surprise, and sometimes utter nonsense seem to be the major hallmarks of the way things end up.

Oil Markets : Yukos Situation Prompts Saudi Promise Of More Oil

Crude oil futures were above $49 and the 50 day moving average on pre U.S. Monday trading. Energy stocks scored a nice looking chart break out last week, but did not follow through on Monday. This is now the traditional bullish season for oil, usually extending until the February-March period. But there is now more to keep an eye on.

Winter might be grabbing the headlines. But the Saudi announcement that it will add production capacity over the next several years, suggests that the kingdom is hearing the footsteps of Russia's Gazprom, as it gets closer to buying Yugansk, the major production asset of the beleaguered Yukos.

This is an interesting situation to keep our eyes on. And the market's lack of movement near the $49 area, suggests that the situation is indeed high on the watch list of most traders.

The key level to watch is still the $48-$49 area and the 50 day moving average.

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