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The Oil Gods Must Be Smiling On Russia


Industries: Energy

The Oil Gods Must Be Smiling on Russia

Soaring prices may allow the country's industry to modernize

It was quite the party: The fifth anniversary of the privatization of Sibneft, Russia's sixth-largest oil producer and 12th-biggest company. For the Sept. 8 bash, Sibneft hired Seventies-style pop group Boney M to entertain a throng at the Hotel Rossiya in Moscow that included the company's largest shareholder, reclusive Russian tycoon and shadowy Kremlin courtier Roman Abramovich. Revelers rocked to Boney M's smash hit: Rah Rah Rasputin--a song hailing an infamous political puppeteer of Russia's pre-revolutionary past.

Sibneft has lots to cheer. Skyrocketing oil prices are projected to boost revenues more than 58%, to $2.7 billion this year, and net profit will almost double, to $613 million, estimates Moscow brokerage United Financial Group (UFG). Indeed, just about everyone in Russian oil is doing a boogie step or two these days--even as consumers in the West worry about Mideast tensions and other uncertainties that could push world prices higher. For the Russian industry as a whole, UFG expects gross sales will rise almost 70%, to $59.2 billion this year. "These revenues are extraordinary," says Mikhail B. Khodorkovsky, chairman and CEO of Yukos Holding, the country's second-largest oil company.

You're right there, Mr. Chairman. The pressing question is whether the boom is enough to give Russia's oil industry the funds it needs to modernize and achieve its potential. There are indeed signs that Russia's oil bosses are starting to act like real managers. But the legacy of mismanagement and corruption will still weigh heavily on this most strategic of Russian industries.INVESTMENT SURGING. There's no doubt the windfall is much needed. The biggest single beneficiary, according to a UFG analysis for BUSINESS WEEK, is the government, whose tax take this year will be fattened by $8.1 billion as a result of the spike in oil prices (table). The government also reaped $1.1 billion in a recent auction of an 85% stake in oil company Onako--more than double the asking price.

But companies are reinvesting funds, too. A surge in capital expenditures, to around $5 billion this year, will push Russian oil production up 5% this year, to 319 million tons--a sharp reversal of a 10-year decline.

To maintain growth, oil analysts and executives estimate that the industry needs to keep this year's investment levels up for at least the next five years. Some companies have already announced major new investment plans--Sibneft next year intends to more than double capital expenditures, to $580 million. Yukos, which this year boosted such spending fivefold to $800 million, next year plans to exceed $1 billion. And they're getting more for their investments. According to Troika Dialog, a Moscow brokerage, efficiency gains and the devalued ruble have cut the costs of extraction from $6 per barrel to $1.50. Managers want to improve that by a further 20%.

The industry is sinking most of its money into new fields, which have not been ruined by Soviet production techniques. Russia's largest oil company, Lukoil, plans to invest $4.7 billion in the north Russian Timan-Pechora Region over the next eight years to triple production from the current 8 million tons per year. Initial drilling costs are quite expensive--but a new well in Timan-Pechora produces 1,000 to 2,000 barrels per day, compared with just 70 from existing wells in western Siberia.

Western advisers are also being recruited. Along with Lukoil and Yukos, Sibneft has hired Schlumberger Ltd., the international energy-services company, to boost productivity from existing wells. Sibneft has also cut corporate fat--reducing operating expenses by 24% last year.

Yet the great Russian oil boom still faces dangers. Khodorkovsky warns that Yukos' investment plans could be crunched if Urals-grade oil, now at $28 per barrel, drops below $18. And he fears Moscow will scotch spending plans further by demanding a high take of revenues even if prices fall.

Another issue is access to foreign capital. Foreign oil companies' direct investment in Russia is still limited, mostly for lack of production sharing agreements to govern the development of fields. President Vladimir V. Putin is promising to introduce new legislation that aims to clear up tricky issues, such as enforcing guarantees to make sure investors are not bilked by changes in the percentages of output they are due to receive. Investors and analysts are optimistic that such legislation will pass next year. "The logjam has been busted on this one," says Matthew Sagers, energy services director at PlanEcon Inc., a Washington think tank.SLUGGISH STOCKS. Bold plans are needed, since only four production sharing agreements have been completed to date. On Oct. 17, BP Amoco PLC, a company with a bitter history in the Russian oil industry, announced an offer to buy a stake in a field governed by one of these agreements--Sakhalin 1, in the Far East. But few Western majors are as brave.

And even though the index of the Russian stock market has nearly doubled over the past 12 months, share prices for most oil companies have not kept pace. That's mostly because of unanswered questions about ownership and perceptions of unfair treatment of minority shareholders.

Thus the dilemma for stock investors. Consider Sibneft, whose share price of 29 cents is virtually unchanged from a year ago, despite a greater-than-anticipated boost in earnings. The company is auditing its books according to U.S. accounting standards, and this year paid its first dividend. "They are trying to be more transparent," says Dmitry Avdeev, a UFG oil analyst. But investors still have few clues about the role played in the company by Abramovich, 34, a former commodities trader. Deutsche Bank analyst Leonid Mirzoyan says investors are suspicious that there is a fund outflow from Sibneft into new Abramovich ventures, including the Russian aluminum business. Sibneft says the suspicions are groundless. Abramovich declined to be interviewed.

Even if shady dealings are still the rule, the petro boom creates other risks. Russia's 409,000 oil workers are frustrated that wages for many remain below the peak before the financial crisis. Companies will have to tackle the pay issue or face a possible surge in worker unrest. A larger issue is that the tax windfall from oil is already reducing pressure for Putin's government to make necessary structural reforms. "Heads are spinning" from the oil windfall, says Putin's top economic adviser, Andrei Illarionov, who's worried about stalled momentum for liberal changes. But few are listening to such party-pooping sentiments. The reigning cry: Let the good times roll.By Paul Starobin and Catherine Belton in MoscowReturn to top


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