Lukoil sets sights on an international top three status

LUKOIL began with three extracting and two processing enterprises in Russia. Today the company includes about 300 companies in over 30 countries and is the leading crude oil producer in Russia. Vagit Alekperov, the president of LUKOIL, sat down with Vladimir Baidashin for a rare extended interview about company results and prospects for development over the next few years.

O&G. At the end of 2006, LUKOIL had an anniversary. How could you characterize the company’s activity over these 15 years?

VA. For 15 years, LUKOIL has taken a significant direction. In 1991 when the company emerged, it was difficult to predict that it would achieve the results we see today in corporate management, financial dimensions and industrial results. In the early 1990s, the company had a task – to retain those entities comprising LUKOIL. In the mid 1990s, the company faced privatization. Today there is dynamic development, output on the global market and transformation of LUKOIL to an international caliber energy company.

We are working very hard. This year the company will invest nearly $9 billion to support industrial growth and the maintenance of fixed capital. As you know, our board of directors in September confirmed a development strategy for the next 10 years. General investments during this period will amount to almost $100 billion. In industrial terms, we put before ourselves a task – to extract 150 million tons of oil and liquid hydrocarbons and 50 billion cubic meters of natural gas annually. These are grandiose tasks, but based upon the resources of our company.

The general reserves of the company today total nearly 30 billion barrels [4.1 billion tons] of provisional hydrocarbons. This is a very significant amount. In addition, the strategy that is based on these sources gives us confidence that we are able to realize those unique projects the company today has undertaken. It includes development of the northern shelf of the Caspian sea, with an annual extraction across the northern Caspian Sea of 16 million tons of liquid hydrocarbons and 15 billion cubic meters of natural gas, and the Timan-Pechora gas and oil province where commissioning is planned in the summer of 2007 for the unique Yuzhno-Khylchuyuskoye deposits together with our partner ConocoPhillips. Together with this American company, we are constructing in the same region the Varandei sea-loading terminal, 20 kilometers from the Barents Sea cost.

I would like to emphasize that the company carries out all projects after careful economic and ecological analysis, assuring that our projects will satisfy the most demanding aspects of ecology, technology and safety.

O&G. How did the anniversary year of 2006 end for the company?

VA. On January 12 of this year in Moscow during the session of the LUKOIL board of directors, we discussed preliminary results of company activities in 2006. In the past year, there was a favorable price conjuncture for oil and oil products on the global and domestic oil markets. For example, in 2006 as compared to 2005, the mid-annual price for Brent grade crude oil grew almost 20 percent, diesel fuel in Europe increased 15 percent, gasoline in Russia (without VAT and excises) grew 19 percent. On the other hand, we had a real strengthening of the ruble, a significant rise in manufacturing prices, Transneft tariffs and an increase in the tax burden, especially export taxes. The mid-annual rate of export duties grew 51 percent on oil, increased 55 percent on light oil products, while the rate of NDPE went up 21 percent.

The main result of activities for the LUKOIL group became a further growth of company capitalization and an increase in its profit. For 2006, capitalization growth totaled 48 percent while other Russian oil companies had an average grown of 40 percent. Based on a preliminary estimation, hydrocarbon extractions of LUKOIL (including production of affiliated enterprises and a share in extraction of joint organizations) were 2.18 million barrels [294,300 tons] of oil equivalent a day, which is 12 percent above the 2005 level.

The crude oil production by the LUKOIL group amounted to 95.2 million tons, including 89.5 million tons on Russian territory and 5.7 million tons abroad. In 2006, the oil production of international projects grew 46 percent as compared to 2005.

Extraction of gas in 2006 has increased more than twofold as compared to 2005, reaching 15.8 billion cubic meters. Such a high rate of production growth results from the commissioning of the Nakhodka gas deposit [Yamal-Nenets autonomous region, in the north of Western Siberia] and because Gazprom buys now all of our gas there as pipeline opportunities have opened. We are optimistic about the growth of gas extraction since the government has indicated that over the next five years the cost of gas in Russia will increase about threefold, as we previously predicted. We even believe that it will happen much earlier than five years. In addition, LUKOIL in 2007 plans to sell one billion cubic meters of natural gas on the Mezhregiongaz exchange platform. We shall consistently increase this volume of gas and in the following year, we plan to reach an annual level of 16 billion cubic meters.

If you will look at the overall view of hydrocarbon extraction, you will see that we have reached the level of our main competitors abroad: ConocoPhillips, Eni [Italy], Total [France], Chevron [US], Petrobras [Brazil] and Repsol [Spain]. But we have set ourselves a more ambitious task – within the new few years – to enter into the top three: ExxonMobil [US], Shell [Royal Dutch/Shell, Netherlands/UK] and BP [UK]. We believe that, unlike our competitors, LUKOIL has two significant advantages: the reserves of hydrocarbons confirmed and proved, that we can use; and most importantly, creative human potential that allows the effective maintenance of these resources.

International projects provided the greatest gain in oil production, followed by Western Siberia due to development of new regional productive deposits and Timan-Pechora. In particular, in Timan-Pechora we already will be producing at Yuzhno-Khylchuyuskoye about 300,000 tons of oil, with the extractions increasing to five million tons the following year and nearly eight million tons in 2009. To be able to achieve this, we had to create absolutely new technologies, not used previously. For example, it was necessary to develop and order tankers of ice class LC with carrying capacity of up to 70,000 tons – which do not exist anywhere in the world. We have begun construction of an ice-proof platform that will allow the year-round shipment of 12 million tons of oil from Varandei and solve several difficult technological problems that no one has worked on yet. Therefore, we have a firm conviction that, in 2008, the Yuzhno-Khylchuyuskoye deposit (our joint venture with ConocoPhillips) will start scheduled hydrocarbon extractions, approximately 100,000 barrels a day the first year, increasing to 150,000 barrels daily in the next year.

LUKOIL is acting progressively as a company offering full production lines in the market not just the raw material. The share of crude oil in the total amount of company sales amounts to only 27 percent, while our Russian competitors are at 50 percent and above. We have set for ourselves a general goal in the near term to stop the sale of crude oil. Our objective is to offer both on Russian and foreign markets 100 percent of our essential value-added products. Practically all global companies process the same volume of oil that they produce. LUKOIL is only at a 45 percent level. This is a primary reason why we do not match the general standards of the largest global companies. Our objective is to overcome such a deficiency in the next few years.

We have already begun work in this direction. Those investments which we have made in downstream Russia, have already paid off today with interest. Currently, the price on the home market, the so-called netback, is much more effective than the export sale of oil. For this reason, we have increased by 20 percent the capacity of oil refineries. As a result, we have made a decision to increase the capacity of our refinery in Nizhniy Novgorod to 18 million tons and in the long-term probably to 20 million tons, while increasing capacity of the Volgograd refinery to nine million tons with a long-term volume goal of 12 million tons. We are considering the possibility of development of heavy oil at the Yaregskoye deposits in the Komi Republic and in this connection processing capacity at the nearby Ukhta refinery could increase up to six million tons, in the long-term up to seven million tons, a year.

For the first time, we have begun to receive profit on those investments made in the transport infrastructure. At the operation of our sea terminal in Vysotsk [Baltic Sea], we have totaled up more than $400 million on a difference of tariffs between those at Baltic ports – of Estonia, Lithuania, Latvia and St.Petersburg – and the tariffs that we use at transshipment of our own oil products. All this has taken place after only 1.5 years of operation. We believe that within a year, all of our investments in Vysotsk will pay back and the company will start receiving additional profit.

At the end of 2007, scale development of deposits on the Caspian Sea shelf will begin. We expect that in 2009 we shall receive the first oil from the Caspian area deposits. Today in Astrakhan the bases for a drilling platform are under construction and drilling will start at the Korchagin field on the Caspian shelf. Investments have actively moved to this region.

O&G. You recently have sold the semi-submersible floating drilling platform Astra. The platform has opened six large oil and gas condensate deposits in the Caspian over the last 10 years. Does this mean that the company will reduce the volume of exploration work in the Caspian Sea?

VA. We believe that all deposits that could be opened in the shallow waters of the Caspian Sea have been opened already. There are shallows where the Astra cannot work and a middle Caspian zone where depths exceed 50-60 meters. The platform cannot produce great volumes, meaning that we would have to rent other platforms. Since we have a program to dispose of unusable assets, we concluded that this was one of those assets. An increase in spare Caspian Sea drilling capacities has resulted from unrealized expectations on the Azerbaijan shelf. Therefore, we do not have a deficiency in exploration drilling capacities. Now, the plan calls for conducting additional exploration at the Filanov deposits. In the following year, we start operational drilling at the Korchagin field and simultaneously we shall explore two deposits on the Caspian shelf, but those will be in deep waters.

O&G. Developing of Western Siberian deposits has taken place for a long time. Does LUKOIL plan to explore other regions?

VA. Western Siberia is our main asset and it will continue its dynamic development. Today in our traditional regions in Western Siberia – Kogalym and Langepas – we have included unique gas projects at the Bolschehetskaya depression [Yamal-Nenets autonomous region]. Therefore, we do not plan a reduction of activity on projects in Western Siberia. On the contrary, we plan a number of moves into the northern Tyumen area to develop the Bolschehetskaya deposits. Therefore, in Western Siberia we have huge prospects for development of hydrocarbons, both liquid and gaseous.

In Western Siberia, due to new purchases that we have made from Marathon Oil Corp. [US] and from Geoilbent, we shall concentrate on stabilizing extraction at Bolschehetskaya. New assets will provide production growth – in the Caspian Sea, Timan-Pechora and projects that we have abroad. The company assets are solid; therefore, we do not see any problems with increasing extraction. The future of Western Siberia remains very good. The company has simulated all deposits of Western Siberia in a three-dimensional supervision method. That gives us a different view of our resources. The company annually compensates for the oil taken at 120 percent. This means that we do not consume those resources that were leftover from our predecessors. On the contrary, we increase them. The company’s overall hydrocarbon reserves grow annually

O&G. What is the LUKOIL position as one of the shareholders in the Caspian pipeline consortium [CPC] concerning an increase in pipeline capacity?

VA. We believe that the second CPC line should take place. CPC shareholders carry on active negotiations with the governments of Russia and Kazakhstan on the conditions of pipeline expansion. We consider that the economy of the project should be coordinated with both parties. I consider it inexpedient to miss an opportunity of such a unique transport corridor passing through Russia.

This interview is reprinted with permission from Feb. 2007 Russian Petroleum Investor, published by WorldTrade Executive, Inc. For more information about Russian Petroleum Investor contact Jay@wtexec.com, or go to http://www.wtexecutive.com.