Lukoil Embarking on a Vast Expansion Program Despite Financial Crisis

Apparently undaunted by the financial and credit crisis, Russia’s Lukoil company has embarked on a vast program of expansion into European Union territory. Where Russian state-controlled companies may encounter resistance, Lukoil presents itself as privately owned. This distinction has, however, become almost meaningless in practical terms in Russia. Moreover, Lukoil is closely associated in a murky, parity-based, partnership with Gazprom’s oil subsidiary, Gazprom Neft.

Earlier this month, LUKoil and the Italian energy group ERG signed a final agreement on establishing a joint venture to operate the giant ISAB oil refining complex on the island of Sicily. Presidents Dmitry Medvedev and Silvio Berlusconi witnessed the signing during Berlusconi’s November 6 visit to Moscow. ISAB’s processing capacity is a staggering 16 million tons of crude oil annually, and it includes installations capable of processing the Russian Urals blend.

Lukoil will pay a mere €1.35 billion ($1.72 billion) for the 49 percent stake, because (as a key to the transaction) it guarantees to supply crude oil for refining. Lukoil paid out the first tranche of €600 million ($764 billion) on December 1 and is expected to complete the cash payment by next September. The joint venture intends to focus on the production of diesel fuel, kerosene, and middle distillates (Vedomosti, November 7; Interfax, November 6, December 1; Ross Business Consulting, December 1).

At the moment, Lukoil is negotiating to buy 29.9 percent of the shares of Spain’s Repsol, the national champion company for oil and gas. If carried out, the purchase would turn Lukoil into the single largest shareholder in Repsol. The Spanish construction conglomerate Sacyr Vallehermoso and the banks La Caixa and Caixa Catalunya, owning 20 percent, 6.1 percent, and 3.8 percent of Repsol, respectively, have been hit by the construction and financial crises and looking to sell their Repsol stakes. For unclear reasons Lukoil is first in line for the purchase. Sacyr Vallehermoso at least has asked the Spanish government to support a bailout in order to avoid selling its stake to Lukoil, but the Moscow-friendly Spanish Socialist government says that it would not become involved in a business matter.

Apparently, Lukoil is offering more than €9 billion ($11.5 billion), including €5.2 billion ($6.6 billion) for Sacyr’s 20 percent and €4 billion for the two banks’ combined 9.9 percent. Conditions attached include: retaining Repsol’s board of directors, limiting Lukoil’s voting share in Repsol to 20 percent, and paying a price higher than the market price of Repsol’s shares. This last condition seems strange for Lukoil to contemplate in light of the credit crunch. Lukoil is said to consider the far-fetched option of mortgaging some of its oil reserves in the ground as a means of financing the purchase in Spain. More conventionally, the Russian company seeks to borrow through a bond issue and is crucially relying on Spanish banks to finance Lukoil’s purchase (Kommersant, November 13; Vedomosti, November 13, 28; Ross Business Consulting, November 25, 27; Gazeta, December 1).

Earlier this year (before the financial crisis struck with full force), Lukoil completed the acquisition of 326 filling stations in the EU member countries Belgium, Poland, the Czech Republic, and Slovakia. Those are mainly JET fuel stations that Lukoil acquired from the American company ConocoPhillips, which holds a 20 percent stake in Lukoil. As a new entrant in those countries, Lukoil intends to expand its fuel distribution market shares and seems poised to take advantage of the difficulties of Grupa Lotos in Poland.

In Slovakia, however, Lukoil’s declared goals are modest: a market share increase from 5 percent to 10 percent within the next five years. The Russian company will market products from the Bratislava-based, Hungarian MOL-owned Slovnaft refinery at least initially. It has declared an interest in close cooperation with Slovnaft, which receives crude oil from the Druzhba pipeline. Lukoil also abjures any ambition to become market leader or to build storage tanks in Slovakia (Hospodarske Noviny, November 25; Trend, November 28). In that case, Lukoil might even become interested (both from a business perspective and politically) in continuing a substantial flow of Russian oil through the Druzhba pipeline, whereas the Russian government had proposed redirecting a large part of that flow northward to Russia’s Baltic ports.

In Croatia, on the other hand, Lukoil’s plans are more ambitious. The Russian company envisages expanding its market share from the 3 percent it now holds to 20 percent by the end of 2011, aiming for a network of 150 filling stations through acquisitions and building new stations. It also proposes to build an oil import terminal and storage tanks on the Adriatic coast (likely to encounter resistance on genuine environmental grounds). Such proposals spell the goal of market dominance and the intention to compete against the Hungarian MOL (Jutarnji List, November 18).

In Russia and Kazakhstan, Lukoil is currently negotiating to buy BP’s 6.6 percent stake in the Caspian Pipeline Consortium’s (CPC) pipeline, which connects Tengiz and other Kazakh oil fields with the Russian Black Sea port of Novorossiysk. With a current throughput close to 30 million tons annually and designed to carry more than 60 million tons per year in the second stage, the CPC pipeline is key to Russia’s goal to absorb the lion’s share of Kazakh oil. Russian sources evaluate the cost of Lukoil’s purchase of the BP stake at $ 2.5 billion (Itar-Tass, November 28; RIA Novosti, December 1).

In Venezuela Lukoil has joined with Rosneft, TNK-BP, and Surgutneftegaz to form a consortium for oilfield development in the Orinoco basin. The Russian companies have begun negotiations with Petroleos de Venezuela on the terms of that vast project. President Medvedev and his Venezuelan counterpart Hugo Chavez announced this plan during Medvedev’s recent visit to that country (Interfax, November 27).

Meanwhile, Lukoil (unlike some other oil companies in Russia) says that it does not plan any personnel reductions or wage cuts, despite the financial crisis. The only declared cost-cutting measure is postponing Lukoil’s plan to modernize and expand its Neftokhim refinery at Burgas in Bulgaria at a projected cost of $1 billion (NewsIn, November 25). That amount is exiguous, however, compared to Lukoil’s overall ambitions for expansion.

Lukoil has asked Russia’s Vnesheconombank for $2 billion in credits toward payment of Lukoil’s debt arrears of some $6 billion, mainly for acquisitions in 2007 (Novaya Gazeta, November 5). How the company can finance its vast plans for expansion remains a mystery for now.