Publication: Prism Volume: 8 Issue: 3

By Sergei Kolchin

When they were still newly established, Russia’s vertically integrated oil and gas companies welcomed the presence of minority shareholders in the capital of their daughter enterprises. It was considered a sign of the democracy and competitiveness of the newly established market environment. But, more recently, they have launched an offensive on their small-scale investors, and the intensity of this attack is steadily increasing.

Take, for example, recent moves by Lukoil to consolidate the capital of its joint venture subsidiaries (Noble Oil, AmKomi, Vatoil and others), or the conflicts between Yukos and TNK and their respective minority shareholders, which have resulted in the latter being forced out of these companies’ daughter enterprises. Similar disputes have arisen in Sibneft, Slavneft and even the famous trading company Nafta-Moskva.

These minority shareholders may roughly be divided into three groups: first, the “untouchables,” who are generally strategic partners of the oil and gas companies, such as Ruhrgaz in Gazprom or BP-Amoco in Sidanko, and who, despite having a relatively small stake in the total shareholder capital, nevertheless enjoy substantial privileges in the area of corporate decisionmaking; second, the “awkward” ones, who cannot be ignored and will not submit to the company’s rules for the game, and with whom it is necessary to negotiate some deal on the redemption of their shares (these are mainly foreign investors such as Kenneth Dart); examples of such agreements have been seen at Lukoil, Yukos, Sibneft and other Russian national oil companies; third, the “domestic” shareholders, whose rights are inadequately protected either by Russian legislation or by the Federal Commission on Securities, although, in the event that there is a major oil and gas corporation amongst these investors, they may be able to do a deal with the parent company. The struggle by Russia’s oil and gas giants for influence over their daughter companies is currently targeted chiefly at this third group.

The tactics used are relatively well established. Either shares in the daughter enterprises are gradually pulled back in favor of the parent company, devaluing the former (this device is possible because of the parent company’s domination of the subsidiary’s management bodies), or the daughter company’s capital is eroded by the issue of additional shares on terms deliberately unattractive to the minority investors.

The motives for ousting minority shareholders from the oil and gas subsidiaries are likewise relatively standard: The minorities tend to be out of tune with the corporations’ policies on asset management and financial operations.

Russia’s top-level oil companies are still seeking to achieve their strategic objectives by forcing minority shareholders out of their daughter enterprises. Now it is Rosneft following suit, having decided on a substantial new issue of shares in Purneftegaz, worth all of 8 billion rubles. The decision to issue 74.2 million Purneftegaz shares is due to be taken at a meeting of the company’s shareholders scheduled for the end of March, but emotions have been running high on the matter since February. It is expected that this additional share issue will be by open subscription, but existing shareholders will be granted preferential rights in the purchase of new stocks. The price for other new investors will be substantially higher. Rosneft has already stated its desire to acquire 51 percent of the new stock and approval of this proposed deal is on the agenda for the March meeting. The minority shareholders find themselves at a disadvantage: Either they pay a relatively high price for shares in the company, over which they still have no control, or they decline to purchase any additional shares and reduce still further their role in Purneftegaz’s share capital. This is not the first time that Rosneft has attacked its subsidiary’s minority shareholders. A year ago an extraordinary meeting of Purneftegaz shareholders approved the sale to Rosneft of assets worth 2.2 billion rubles (about 20 percent of its stock) and, at the same time, the leasing of this property back to the daughter company. In August 2000, too, a similar transaction involving an even larger sum had been approved. As a result, Purneftegaz has effectively been turned into an operating company for Rosneft. The additional share issue currently on the table may be seen as the logical conclusion of the process of Rosneft’s absorption of Purneftegaz.

Apart from Rosneft, which is still a state-owned oil company, and whose attempts to consolidate its subsidiary’s share capital may be regarded as pre-sale preparations, almost all of Russia’s current privatized oil and gas corporations have also clashed with their minority shareholders. Yukos, for example, is in conflict with minority shareholders in the Angarsk Petrochemical Company over the still unresolved issue of Yukos’ acquisition of the Eastern Oil Company (VNK), although Yukos has been trying to preempt the problem by reaching an agreement with the VNK subsidiary, which has become a target for minority shareholders from Samara. The Tyumen Oil Company (TNK) has also run into active opposition from its minority shareholders over its program for consolidating the capital of its subsidiary extraction enterprises. TNK converted their shares into holding stocks at a higher face value and any fractional shares presented subsequently were designated for redemption. The minority investors held that their shares were worth at least twice as much as they were being offered and refused to exchange them on TNK’s terms. This was the line taken in particular by representatives of the Astian Group stake. Sibneft met similar opposition to its moves to consolidate the capital of its daughter enterprises.

Ultimately, conflicts between the oil and gas corporations and their minority shareholders can be resolved with some degree of compromise between the interests of the various parties. But the process of ousting of minority investors from the share capital of the corporations and their daughter structures continues unabated.

Seen in this light, Lukoil’s decision to increase minority shareholder representation on the company’s board of directors may seem somewhat paradoxical. But the paradox is only apparent, because the shareholders concerned are in fact of the first type listed above, namely Lukoil’s major foreign partners, such as the successor to ARCO, BP-Amoco. But Lukoil is still having problems with its small shareholders, particularly on aspects of the company’s management of a recently purchased Bulgarian oil refinery.

Gazprom has followed the example of the oil companies, too. Having found a foreign partner for the development of two gigantic off-shore deposits, the Prirazlomny and Shtokman fields, Gazprom decided to oust the minority shareholders from Rosshelf, the company designated to develop the fields. As a result, Rosshelf’s board of directors, which is dominated by Gazprom, decided to call an extraordinary meeting of its shareholders, with the aim of securing approval for a new share issue (100 million shares at 100 rubles each). Gazprom means to purchase the new shares not with cash but by offsetting them against Rosshelf’s debts, which amount to some US$150 million. This will give Gazprom an advantage over the other shareholders. The minority shareholders are naturally unhappy with this, but Gazprom is in a stronger position on Rosshelf’s board of directors. “We don’t understand why a new share issue by Rosshelf is necessary,” said a Lukoil representative. “If funds are needed to develop the new deposits, wouldn’t it be simpler for shareholders to contribute directly to the project?” But Gazprom, it seems, understands perfectly well why the additional share issue is needed–as a way of forcing the minority shareholders out. The way the share issue is being used to this end is nothing new for Russia. Some of Rosshelf’s minority shareholders, such as Severstal, have already decided not to purchase any of the new stock. It is entirely possible, however, that mechanisms will be found for working out some sort of deal between Gazprom and some of its minority shareholders, especially Lukoil.

To sum up, Russia’s oil and gas sector is consolidating its capital by suppressing its minority shareholders. The extent to which they can insist upon their rights varies, with the result that some are able to stand firm and even profit from the situation, while others lose out when they are forced to play the game by the rules imposed on them by the corporations.

Dr. Sergei Kolchin heads the sector of economic statistics and comparative international analysis of the Russia Academy of Sciences’ Institute of International Economic and Political Studies in Moscow.