Seizing the opportunity

By Ben Thompson, Senior Editor

Crisis? What crisis? According to Lukoil Chairman and CEO Vagit Alekperov, the current economic downturn is just another opportunity for the oil and gas industry to emerge even stronger than before.

At the recent European Business Summit in Brussels, most of the talk centred, unsurprisingly, around how best to deal with the current financial crisis. Jose Manuel Barroso, President of the European Commission, bemoaned the lack of confidence in the current market. Günter Verheugen, the European commissioner for enterprise and industry, warned of the threat of protectionism from the United States. And Ernest-Antoine Seillière, President of employers’ organisation BusinessEurope, suggested that the current economic downturn could last for as long as two years.

But not all of the assembled industry heavyweights were so downbeat. Vagit Alekperov, for one, chose to put a different spin on things. “The current crisis is by no means the first, nor will it be the last, in the global oil industry,” the tough-talking head of Russian oil and gas juggernaut Lukoil told a packed audience. The trick, he said, is to think of such times as a chance to reshape elements of the industry that are not working. And in his opinion, there is plenty of scope for improvement in the current system.

Such an approach is typical of a man often hailed as one of the great opportunists of post-communist Russia. In less than 20 years since the break up of the Soviet Union, Alekperov has created a company that has become not just a global player in petroleum but also the face of Russian business abroad. It has operations in more than 40 countries, generated turnovers of US$80 billion last year, and among the world’s independent oil companies is second only to ExxonMobil in terms of the size of its reserves – which at the beginning of 2007 stood at 15,715 million barrels of crude oil and 27,921 billion cubic feet of natural gas, totaling 20,369 million barrels of oil equivalent.

For Alekperov, the current crisis represents the latest in a long line of setbacks that have ultimately resulted in a stronger oil and gas industry. “Each new crisis not only brings in threats, but also new opportunities,” he says, citing the examples of 1973, when OPEC’s oil embargo resulted in the crude price surge, and 1998, when prices plummeted following the collapse of the Asian stock market. “The mid-1970s saw an investment boom into development of new fields outside OPEC, as well as into alternative energy, and we are still benefiting from the fruits of that boom. The 1998 crisis, meanwhile, triggered a number of mergers and acquisitions in the oil and gas industry. The supermajors made a breakthrough in the development of deepwater shelf and oil-bearing sandstones, and significantly expanded global LNG production and transportation capacity.”

Energy crossroads
He suggests we now stand at another such crossroads, and the choices taken now could have a profound effect on the sector for years to come. So what opportunities does the new global crisis open up for the oil and gas industry? “First of all, it is obvious that the current energy market is not efficient enough,” he asserts. “Over recent years, due to the tremendous growth in the financial instruments trade, the oil price dynamics no longer reflect the actual supply/demand balance. However, unpredictable and dramatic price fluctuations offer no advantage for either consumers or producers. Both are interested in fair oil prices that, on the one hand, encourage replacement of reserves, and on the other, support demand for hydrocarbons.”

As such, Alekperov believes the crisis is a good time to develop new pricing mechanisms, since it helps shrink the financial bubble and increase the role of commodity markets. “The key factor of setting a fair price may be in limiting the use of oil quotes in speculative financial transactions, reducing spot market trade volumes and making direct long-term contracts between feedstock producers and consumers,” he says.

Another feature of the current energy market that impedes its efficient operation is the lack of confidence between suppliers and consumers. It is a subject Alekperov feels strongly about. “We fully support the initiative of integrating European energy markets, developing common standards and a common energy policy within the European Union. However, we cannot help but be concerned about the opposing views between the EU and Russia, between the EU as a huge consumer and Russia as a major supplier,” he warns, suggesting the current scenario is a throwback to the 1970s, when OPEC countries agreed to coordinate their policies in order to get rid of what he refers to as the “dictatorship” of the major consumers in Europe and the USA.

He firmly believes the only way to address this lack of confidence between suppliers and consumers is to establish a relationship based not on price but on excellence. “In recent years, crucial developments have taken place,” he explains. “Interdependence of suppliers and consumers has increased a hundredfold. The current market state is no longer determined by the negotiation positions of consumers and suppliers, but by the operational excellence of key ‘energy corridors’ that ensure production, transportation and refining of feedstock, as well as marketing of finished products.”

Such a corridor is not just a supply chain, says Alekperov, but a system of strategic partnerships between consumers and suppliers. “Excellence in using such a system is subject to the following conditions,” he suggests. “Mutual trust and openness to dialogue; encouragement of mutual investments; no intermediaries; and information transparency. I am convinced that the crisis will induce both the consumers and the producers to seek new forms of cooperation.”

Better collaboration
Indeed, the importance of establishing better levels of collaboration has moved up the agenda for both Lukoil and its partners in recent months following the gas disputes between Russia and Ukraine earlier this year that caused major disruptions to the energy supply chain.

“Today, as we are facing low oil prices and lack of access to credit resources, it is the producers who are most interested in partnership development, since they need investments and guaranteed market outlets for their products,” says Alekperov. “Tomorrow, as the global economy begins to recover and the oil and gas sector sees a major decline in production volumes resulting from underinvestment, it will be the consumers who will seek cooperation opportunities. In any case, only closer relations between producers and consumers can help prevent the financial and economic crisis developing into a full-blown global energy crisis.”

This is certainly true for the relations between Russia and the European Union. The issue of energy cooperation between Russia and the EU is of utmost importance for Lukoil, given that Europe represents the company’s key sales market. Three out of eight of the company’s refineries and almost one-third of the company’s filling stations are located in the EU, while Lukoil’s total investment into Eurozone economies currently exceeds US$5 billion. “We comply with the EU legislation and consider ourselves a European company just as much as we are a Russian one,” maintains Alekperov. “Therefore, we cannot help but be concerned with the fact that the Russia-EU energy corridor is not as stable as we all want it to be.

“The level of mutual investment penetration in the oil and gas sector is still low. We are yet to resolve the issue of transfer of the energy carriers through third-party states. Cooperation in the fields of renewable energy, energy saving and environmental protection is not developing fast enough. “I believe we should take advantage of the crisis to address these systemic issues in our relations,” concludes Alekperov. “This is necessary if we want Russia and the European Union to enter the new economic cycle, which will begin a few years from now, as strategic partners in the field of energy.”

Lukoil today
• Represents 1.3% of global oil reserves and 2.3% of global oil production
• Accounts for 18.6% of Russian oil production and 18.1% of Russian oil refining
• Is the second largest non-state publicly traded oil company worldwide by proven reserves of hydrocarbons
• Is the sixth largest non-state publicly traded oil company worldwide by production of hydrocarbons
• Is the largest Russian oil business group with annual turnover of over US$80 billion and net income of US$9.5 billion
• Was the first Russian company to receive full listing on the London Stock Exchange
• Is a leader among Russian oil companies for openness and transparency
• Is the only private Russian oil company whose share capital is dominated by minority stakeholders
• Is one of the largest tax payers of the Russian Federation (total amount of taxes paid in 2007 was US$28 billion)

Global reach
Lukoil has a significant portfolio of production assets, with the main production region for the group located in Western Siberia. The company is also carrying out international exploration and production projects in Kazakhstan, Egypt, Azerbaijan, Uzbekistan, Saudi Arabia, Colombia, Venezuela, Cote d’Ivoire, Ghana and Iraq.

With the development of the Nakhodkinskoye gas field in 2005, the company further demonstrated its ambitions in the gas sector, and is targeting rapid growth in natural gas production. The key regions for development are the Bolshekhetskaya Depression, the Northern Caspian and Tsentralno-Astrakhanskoye field in Russia, as well as the Kandym-Khauzak-Shady project in Uzbekistan (which went into production in 2007) and the Shakh Deniz project in Azerbaijan.

In addition to its production capabilities, Lukoil also owns significant oil refining capacity both in Russia and abroad. In Russia, the company owns four large refineries at Perm, Volgograd, Ukhta and Nizhny Novgorod, with a total capacity of 44.5 million tons of oil per year. Lukoil also has refineries in Ukraine, Bulgaria and Romania with a total capacity of 14.0 million tons per year. In 2007, LUKOIL refined 52.16 million tons of oil at its own refineries, including 42.55 million tons in Russia.

In 2008, the company’s marketing network encompassed Russia, European countries (Azerbaijan, Belarus, Georgia, Moldova, Ukraine, Bulgaria, Hungary, Finland, Estonia, Latvia, Lithuania, Poland, Serbia, Montenegro, Romania, Macedonia, Cyprus, Turkey, Belgium, Luxemburg, Czech Republic and Slovakia) and the USA, and includes 197 tank farm facilities with total capacity of 3.11 million cubic meters as well as 6090 filling stations, including franchises.

2009 investment
Lukoil recently announced that its total investment in 2009 will be around $8 billion, a figure that represents a 25-30 percent reduction compared with 2008., but that will still enable the company to boost crude output by 1.5-1.8 percent this year. Of this figure, Lukoil’s foreign investment will total $1.5 billion this year. “This amount will enable us to fulfil all our obligations on our overseas projects,” Alekperov said in a recent interview with the international news channel Russia Today.