LUKOIL: RUSSIA’S TROJAN HORSE IN THE NEAR ABROAD?

LUKoil: Russia’s Trojan Horse in the Near Abroad?

By Rossen Vassilev

On March 15, Russia’s Communist-dominated State Duma voted overwhelmingly in favor of a resolution calling for the restoration of the old Soviet Union. But Moscow has for quite some time been pushing hard for the economic, military and political reintegration of the former Soviet republics. Oil diplomacy in the countries of the "near abroad" has been a major instrument in Russia’s drive to rebuild its previous sphere of influence.

An important player in the Kremlin’s increasingly assertive strategy is LUKoil, Russia’s oil giant, which is the second largest oil company in the world after Royal Dutch-Shell in terms of reserves, and the eighth largest in terms of production. (1) With expected earnings of $415 million in 1995, LUKoil is one of the strongest economic players vying for power and influence in Russia. It is scheduled to trade up to 15 percent of its shares on the New York and London stock exchanges next year. (2) LUKoil’s colorful president, Vagit Alekperov, is ranked third among Russia’s most powerful business leaders. (3)

He is also a strong supporter of President Yeltsin. This is hardly surprising, since as Mikhail Gorbachev said in a recent interview with CNN, Yeltsin is the voice of Russia’s "new financial oligarchy." In February, Alekperov joined the leaders of other major Russian oil companies in urging the president to run for re-election in June. In an open letter published in Rossiiskiye vesti, a government-run daily, the Union of Oil Industrialists also expressed unqualified support for Yeltsin’s economic policies.

Even though the Russian state reportedly holds only a 5 percent share in LUKoil, a strategic partnership has developed between the two. Because the oil company sells cheap, subsidized fuel to state farms and the cash-starved Russian military, the Yeltsin government has allowed it to defer its taxes as long-term, interest-free loans. Even an expected Zyuganov victory in the June presidential election would be unlikely to disrupt LUKoil’s cozy ties to the government since the Communists are known to favor the renationalization of "strategic" industries like the energy sector.

LUKoil, the biggest Russian privatized oil company, plays a pivotal role in the Kremlin’s use of oil to advance its economic and political goals abroad. These include reasserting Moscow’s authority in the CIS to ensure that Russia gets priority in exploiting the vast resources of the former Soviet Union as well as promoting the long-term reintegration of the former Soviet republics under Russian tutelage.

LUKoil was founded just four years ago by Alekperov, who built it into what is probably the most successful, Western-style industrial conglomerate in Russia. Born in Baku forty-five years ago, Alekperov has been described as the archetype of the new Russian businessman — a modern industrial capitalist and a shrewd political operator. (4) Formerly a hard-driving production manager of one of the Soviet Union’s biggest oil fields in Siberia, he was brought to Moscow in 1990 as deputy minister of oil production.

After the August 1991 coup de theater, the oilman from the Siberian taiga served as acting minister of oil production until the dissolution of the Soviet Union four months later. Like other members of the old Soviet industrial elite, Alekperov successfully transformed his privileged position, skills and connections into economic power and political influence in the emerging capitalist order. Using the financial, managerial and legal services of Western companies such as CS First Boston and Paribas Capital Markets, he consolidated several different state-owned enterprises to create LUKoil, a modern industrial corporation with diversified interests. Out of the chaos accompanying the collapse of Soviet communism, the publicly-traded LUKoil emerged as Russia’s largest oil producer, handling everything from production and transportation to distribution.

Like many new Russian businesses, LUKoil was built on a foundation of mafia-like political connections. In a not-so-subtle form of bribery, Alekperov gave away a large number of LUKoil shares to key power brokers in Moscow, including Yuri Shafranik, Yeltsin’s fuel and energy minister. (5) The new economic powerhouse soon began to look for fresh acquisitions in the former Soviet republics. The Russians came up with a predatory but remarkably effective strategy for grabbing a piece of the action in some of the most important oil projects in the CIS.

Working hand in glove with the new government under Yeltsin, LUKoil aggressively began to push Russia’s claims in the "near abroad." Alekperov was the perfect man for the job. As head of the Fuel and Energy Ministry in 1991, he had developed a wide range of personal contacts and friendships, including with former ministry subordinates who today are in charge of the oil industries of several Transcaucasian and Central Asian states. (6)

LUKoil’s first major success was in Alekperov’s own Azeri homeland. In the summer of 1993, a $8 billion oil deal was being negotiated between the government in Baku and a Western consortium led by BP and Amoco. But after two years of negotiations, the Azeris were slow in committing themselves to an agreement and were demanding huge bribes from their Western partners.

It was at this delicate moment that Alekperov made his move. Citing Moscow’s huge past investments in the Baku oil fields, LUKoil demanded a share in the profitable new venture. The demand was backed by the Russian Foreign Ministry and the Fuel and Energy Ministry. Using its monopoly over the old Soviet pipeline system as a bargaining chip, the Russian government made an offer that Baku could not refuse. To back up their claims, the Russians offered pipeline access for Caspian oil exports at reduced tariff rates, at the same time that Moscow-sponsored political violence threatened to disrupt alternative transportation networks in the area.

Despite Azeri and Western misgivings about giving the Russians a role in the so-called "deal of the century," Azeri president Heydar Aliyev offered LUKoil a 10 percent stake in the consortium for a mere $15 million. The final agreement, which involves three major offshore oil fields with total recoverable reserves of at least 4.5 billion barrels, was signed in September 1994. The significance of LUKoil’s victory should be measured in more than just future profits. It set the stage for a Russian-American competition for influence in the oil-bearing and strategically- located Caucasus. This was made clear by the subsequent diplomatic wrangling over the pipeline routes to transport Azeri oil to world markets.

To give the American-led consortium a degree of independence from Moscow, Washington lobbied the government in Baku hard to export the bulk of Caspian oil through Georgia and NATO-ally Turkey. But LUKoil seemed to have as much of a say as the White House, for under a compromise agreement announced in October the so-called "early oil" from Azerbaijan is to be pumped via both the American-favored Georgian pipeline and a Russian pipeline leading to the Black Sea port of Novorossiisk.While no final decision has been reached about the long-term export routes, Moscow has reached a tentative agreement with Azerbaijan that part of its Caspian oil will flow through the Russian pipeline. To put the squeeze on Baku, the Russian Foreign Ministry has raised legal objections to Azeri exploitation of the Caspian Sea, insisting that any decisions on the use of its resources be made by a body comprised of all five littoral states. Meanwhile, LUKoil is trying to undercut the alternative Georgian route by offering to buy all "early oil," scheduled to start flowing by the end of this year.

This first success set a precedent for a number of other equally Machiavellian intrigues. Under pressure from Moscow, LUKoil obtained the largest share (32.5 percent) in another oil project, the Karabakh field in Azerbaijan’s Caspian shelf, which contains up to 1 billion barrels. (7) Russia’s fuel and energy minister Shafranik, a major LUKoil shareholder, hailed the signing of the Karabakh agreement as "a tremendous victory for the Russian oil industry and Russian diplomacy."

In February, Alekperov signed an agreement for the participation of LUKoil in a $4 billion contract to develop Shakh-Deniz, another deep-sea oil field in the Azeri section of the Caspian. (8) This is the third Western-led project in Azerbaijan into which LUKoil has muscled itself.

At LUKoil’s urging, the Yeltsin government demanded a stake in the Texaco-led Timan-Pechora project in the Arctic. Moscow threatened unspecified sanctions if it did not have its way. Rather than be shut out of the Russian market, the Americans caved in and granted the Russians a 20 percent concession.

LUKoil has also put the squeeze on Chevron and the government of Kazakhstan in their joint Tenghiz project, which has estimated reserves of some 9 billion barrels. Shafranik cheated Chevron (which had 50 percent ownership in the venture) by giving it only a third of the Russian pipeline capacity that had been originally promised. He also reminded Kazakhstan, which is still dependent on Russian energy imports, that it owed Moscow 1.5 trillion rubles for oil and natural gas. The Tenghiz-Chevron producers, who had already invested nearly $1 billion in the project, discovered that because Moscow controlled the pumps they had no choice but to include the Russians in the $20 billion production-sharing agreement.

As a result, LUKoil (which originally sought a 20 percent share in Tenghiz-Chevron) has become a major production partner and will lead the pipeline consortium, thus resolving the pipeline dispute. The Russians have also been promised a place at the table in other Kazakh energy ventures, including the development of the promising Karachaganak oil and natural gas fields. LUKoil already has a 26 percent stake in the seaport facilities at Novorossiisk, where both the Tenghiz pipeline and the Baku pipeline will terminate, and is negotiating with Western banks for the construction of a $1.3 billion petrochemical refinery near the oil terminals.

The Yeltsin government has recently designated LUKoil as the sole coordinator of all Russian hydrocarbon exploration in the Caspian Basin. The economic stakes in the oil-rich region are enormous. The Caspian is currently estimated to have 16-32 billion barrels of proven recoverable reserves and 68-250 billion barrels of potential reserves — the world’s largest oil reserves after the Persian Gulf and Russia itself. (9) Moscow wants to be a central actor in any plans to develop and exploit these vast resources. With LUKoil set to take a large share in all major energy projects, it is clear that Moscow’s economic and strategic clout in the region will grow.

LUKoil’s ventures outside the CIS have served Russian foreign policy goals well, including that of reviving cooperation with Soviet-era partners and clients. It has developed a close production partnership with the Italian oil company Agip (called LUKAgip) in the Caspian and North Africa, especially in Egypt and Tunisia.

The Russians are also interested in resuming operations in Iraq. The Soviet Union helped build the Iraqi oil industry and financially-strapped Moscow is now eager to return to this once profitable market. A year ago, a Russian delegation led by Shafranik signed energy deals in Baghdad reportedly worth $11 billion. LUKoil, which wants to drill for oil in the Iraqi desert, has secured a 70 percent stake in a contract worth $2 to $7 billion to develop the West Quarnah oil field, which contains about 7 billion barrels. (10) LUKoil’s future deals with Iraq may involve trading oil for settling Iraqi debts to Russia, estimated at $5 to $10 billion. (11)

The Russians are involved in several other Iraqi projects, including the huge Rumeilah oil field. The Russian Foreign Ministry is backing LUKoil’s plans by pushing for the lifting of UN sanctions against Baghdad. LUKoil is also exploring production-sharing contracts with another American arch-enemy, the government of Iran.

Although its own energy industry is in a shambles (oil output has fallen to barely half its mid-1980s peak), Moscow has been maneuvering to regain control over the exploration, production and transportation of oil and natural gas in the "near abroad," hoping to secure a dominant position for itself. With LUKoil effectively in charge of Russian oil policy throughout the CIS, Moscow believes that control over local energy projects will strengthen its strategic position in the former Soviet republics. In America’s fascination with the rise of a market economy in Russia, the Kremlin’s symbiotic relationship with LUKoil and other Russian businesses in pursuing its economic and strategic interests abroad has attracted less attention than it deserves.

NOTES:

1. The Moscow Times, February 27, 1996.

2. The Oil Daily, February 12, 1996.

3. Ekonomika i zhizn, February 8, 1996.

4. The Moscow Times, February 27, 1996.

5. Ibid.

6. Ibid.

7. Segodnya, February 14, 1996.

8. Kommersant-daily, February 17, 1996.

9. Jane’s Intelligence Review, February 1, 1996.

10. Interfax, February 13, 1996.

11. The Moscow Times, February 16, 1996.