Western Multinationals and Yukos Closer to Merger

Abstract: Were Dr. Zhivago alive today, he'd chronicle the intense romantic pursuit of Yukos, the Russian oil giant, by well-heeled Western multinationals. But it will take a $12 billion ring to finalize the engagement.

Analysis: With the press and public deeply focused on the demise of the engagement between entertainment superstars J Lo and Ben, a second whirlwind courtship has largely been overlooked in the last couple weeks.

This one involves two possible suitors, each of whom is rumored to be on the verge of popping the question.

The intended bride is Yukos, the Russian oil giant. Potential grooms include ChevronTexaco and ExxonMobil with ExxonMobil quickly moving up as the favorite to bring the relationship to consummation.

The deal involves a potential $12 billion investment for a 25-percent stake in YukosSibneft, assuming the announced merger with Sibneft goes forward as anticipated. The Russian government okayed the Yukos/Sibneft merger last month. It would create a $40 billion petroleum giant with vast reserves and low-cost oil production in Siberia.

Furthermore, a survey of international press reports indicates that Roman Abramovich, the major stakeholder in Sibneft is reportedly interested in parting with some--or all--of his Sibneft stake. This would open the door for a potential deal with Western multinationals.

For ExxonMobil, the motivations are straightforward. The investment would broaden the company's participation in the Russian oilpatch beyond its Sakhalin 3 exploration project. As with other giant Western multinationals, ExxonMobil faces daunting challenges in growing its reserves significantly. YukosSibneft offers access to substantial low-cost volume production from copious reserves in the eastern Siberian oilpatch.

The motivations for Yukos are equally straightforward. The company is open to merging its operations with a Western multinational as a means of entering the international arena and diversifying beyond its deep ties to the Russian marketplace. That interest has grown keener over the Russian government's dissatisfaction with Yukos CEO Mikhail Khodorkovsky's involvement in regional Russian politics.

Ninety days ago, representatives of the Russian government barged into Yukos' Moscow offices, seizing files, computers, and subjecting staff members to intensive interrogation. The month of July was filled with daily updates in the Russian press as members of the Russian government and Yukos publicly exchanged an escalating series of allegations and accusations. The swirl of charges involved the usual--such as bribery and corruption--and the unusual--including murder and assassination. A key Yukos shareholder was imprisoned, though not formally charged.

The unexpected events led to speculation that private property safeguards were being subverted to internal politics, making Western-style investment in Russia even riskier in a country where many Western firms have provided investment dollars, though few have retrieved anything out of the country remotely resembling profit.

The Yukos raid was interpreted as the end of an informal agreement which Russian president Vladimir Putin established with Russian business oligarchs in 2000. That agreement specified that the Russian government would not look too deeply at any of the firms who acquired state assets in questionable deals in the post-Soviet privatization effort as long as the oligarchs stayed out of the political arena.

Yukos CEO Mikhail Khodorkovsky apparently crossed the line by financing a series of regional opposition candidates, think tanks, and media ventures in anticipation of the upcoming Russian Duma elections this December.

While a merger with a Western multinational would provide Mr. Khodorkovsky an opportunity to monetize some of his assets, it would also help him achieve some protection against further government harassment since he would have an influential Western ally in a country that would like to attract additional Western investment dollars.

The collapse of the informal agreement between Mr. Putin and Russian business oligarchs brought a round of speculation that foreign investment would soon tail off because of the harsh realities of internal politics and its threat to property rights. However, the public charges and countercharges involving Yukos and the Russian government largely subsided in the last couple months.

In its place has come renewed talk that ExxonMobil, ChevronTexaco, or other Western multinationals are in some form of advanced discussion with Yukos and Sibneft. Last month, ChevronTexaco was rumored to be the main candidate. More recently, the emphasis has shifted to ExxonMobil, which has more than a quarter of a trillion dollars in cash available for investment.

Impetus to move forward on some kind of deal emanates from several factors. One is the fact that the BP/TNK investment has been finalized. Indeed, the current round of interest in the Russian oilpatch among Western multinationals followed BP's surprise announcement last February that it was investing $6.5 billion for a 50-percent stake in TNK, a company with which it had previously been at odds over resolution of complications stemming from an earlier investment joint venture in Russia.

A second motive is the recent spat between ExxonMobil and Saudi Arabia over the collapse of the Saudi gas initiative. ExxonMobil and its champions in the ruling family fell out as the gas initiative entered its final stages. Some argue the initiative was hand-tailored by the Saudi royal family as an easy entrée for the multinational into an expanded role in the kingdom's business affairs.

The deal collapsed for a number of reasons, among them the fact that growing anti-Saudi sentiment in the U.S. made it difficult for ExxonMobil's backers in the Saudi ruling family to press their case.

Once the arrangement dissolved, ExxonMobil was rumored to have intensified its interest in seeking a rival deal in Russia, which has had its own spats with the Saudis over production levels in recent years.

Of course rumors of an imminent deal involving Yukos and a Western multinational have been circulating for most of 2003. Last week's international energy summit in St. Petersburg served as the latest forum to revive speculation.

ChevronTexaco CEO David O'Reilly this month identified Russia and the Middle East as areas in which his company would like to invest. The company has a cash reserve of $10 billion earmarked for investment and already has production in the Tengiz and Tarachaganak fields in Kazakhstan.

In fact announcements of Western involvement in the Russian oilpatch are now weekly events. The Oil and Gas Journal has carried commentary, and an article appeared in the Wall Street Journal just last week on the Yukos/Western multinational romance.

Additionally, Royal Dutch/Shell this month announced a $1 billion investment in a Siberian oilfield with its partner, Sibir Energy. The deal provides Shell with its first foothold in the western Siberian oilpatch. Shell is also moving forward with development of Sakhalin II. The $10 billion offshore project will create an LNG plant on the island, exporting LNG to the Far East. Shell is also trying to restart negotiations to form a potential alliance with Gazprom for building gas pipelines and exploring for and developing Russia's sizeable natural gas fields.

Russia is the Saudi Arabia of natural gas reserves.

Other deals--rumored and real--have broadened interest in Russia beyond just petroleum reserves. Key Energy Services has established a working partnership with a Russian service firm, StroyTransGaz. The arrangement involves training Russian employees in U.S. style well-servicing operations focusing on safety, equipment management, and technology. StroyTransGaz is Russia's largest well service company.

Meanwhile Nabors Industries has been in talks with LukOil over a potential joint venture with the Russian company's oil services division.

Of course the major excitement still centers on Yukos and its rumored engagement to a wealthy Western multinational. The story involves as much romantic intrigue as can be found among the young, glamorous, and famous in Hollywood.

Can't wait to see the movie.