Incomplete Privatization Mixes Ownership Of Russia's Oil Industry

Eugene M. Khartukov
International Center for Petroleum Business Studies
Moscow

Indeed, the rapid and controversial privatization of Russian oil is far from complete, and its current ownership and management patterns leave too much room for questioning and speculation. Not surprisingly, few western analysts are able to properly determine a scope and degree of the remaining state control over the industry. Russian observers are also ill-informed.

Consequently, assessments of the current state stake in, say, the country's largest oil company, Lukoil, typically oscillate from 0% to 50%; in fact, excluding 24.5% of the company's shares put aside for new holders, at present the state definitely owns just under 11.6% of the equity (Table 1) [32,556 bytes].

Semi-state; semi-private?

Beginning at the end of 1992, the restructuring affected 300 formerly independent but fully state-controlled production associations (amalgamations), enterprises, and research centers dealing with oil exploration, production, refining, and product distribution in Russia. These concerns have gradually developed into a baker's dozen of vertically integrated and partly privatized oil companies, led by the oldest Russian majors: Lukoil, Yukos, and Surgutneftegaz (SNG; Table 2) [69,614 bytes].

Established initially as wholly state-owned, each of those companies was to be fully privatized through a successive sell-off of its state controlling stake. From the very beginning, 45% or 51% of every new company's equity was reserved as federal property for 3 consecutive years, whereas the remaining shares were offered, by installments, to the company's employees (at low prices and even free) and to outside investors (through cash auctions and investment tenders).

At the end of 1995, the Russian government undertook a notorious "shares-for-loans" scheme aiming at patching the deplorable federal budget. Within 2 months, all the reserved federal property in Sidanko, Sibneft, Yukos, and SNG, as well as a 5% federal stake in Lukoil and 15% from a 44% federal interest in Nafta Moskva (former oil export monopoly Sojuznefteexport), were pledged against commercial loans offered by a handful of Russian financial institutions through a series of collateral auctions. As a result, the auction winners took actual control of the pawned oil companies.

Under all the concluded collateral deals, by Sept. 1, 1996, the government had to make a difficult choice between returning and retaining the borrowed money-altogether over $530 million-or, in other words, between restoring and losing its control of the pledged property. A week after the deadline, President Boris Yeltsin signed a special decree extending federal ownership of equity shares in unspecified fuel and energy companies that have "strategic importance for safeguarding the national security" until Dec. 31, 1998; however, no final decision was publicly made on the "shares-for-loans" dilemma.

Hence, in theory, the confused pledgeholders have acquired title to the collateral and now may keep or sell their new possessions without a nod from the previous owner. In practice, however, no business (including major commercial banks) can feel comfortable in Russia by quarreling with omnipresent and powerful executive authorities. Moreover, no lucrative secondary market for the controversial equity is likely to emerge before its title is finally clarified.

Proceeding with auction

In a bid for settling oil companies' enormous debts to the budget, starting from last August, federal authorities have been tendering the remainder of nonreserved stakes in major oil companies. In particular, 34% of Sidanco stock (a leftover of state shares after pledging the federally reserved 51%) was sold outright at an investment auction last September. In turn, Signeft was completely stripped of the remaining state holding through three successive sales of nonreserved shares in September (19%), October (15%), and December (0.7%).

Last December, Tatarstan's national oil company, Tatneft, reduced the state stake to just over 35% by selling 11.5% of its equity to foreign investors through ADS bids held in London and New York. Also, as a result of investment tenders completed at the very end of 1996, state control of Nafta Moskva was curtailed by an additional 14%, to just 15%, while the state holding in Vostsibneftegaz (East Siberian Oil & Gas Co.) shrank by more than 47% (won by Sibneft), to 38%.

Those sales were followed by January tenders and auctions which "freed" the state of the 51% pledged interest in Sidanco of a 2.1% stake in the transnational Slavneft, and of a 38% holding in Komitek. Another major tender, held last February, completed intracompany privatization of Surgutneftegaz (SNG), which in turn won 14.99% of the remaining 15% federal stake in Nafta Moskva at a virtually predetermined tender last April. A series of March and April auctions trimmed the remaining state participation in Komitek to less than 22%. Last May, a duet of Stolichny Savings Bank (SBS) and Oil Financial Co. (NFK)-the pledgeholders of Sibneft's 51%-changed the uncertain status of this quasi-state property by selling the pledged shares to another "independent" investor-Financial Oil Corp. (FNK), affiliated with SBS.

More privatization

At the same time, a duet of SBS and NFK-pledgeholders of Sibneft's 51%-is likely to change the uncertain status of this quasi-state property by selling the pledged shares to another "independent" investor.

Furthermore, 1997 can see the long-awaited privatization of the state monopolistic ownership of Russia's oil pipeline operator Transneft. Starting from last August, the company began to distribute 25% of its stock in the form of complimentary preferred shares among more than 76,000 present and former employees, with a further tranche of state-held shares (presumably up to 24% of Transneft's total assets) likely to be offered to investors before 1998.

The same schedule seems probable for partial (up to 49%) privatization of Rosneft, which has been delayed by its endless squabble with Sidanco over affiliation of the 170,000 b/d producer Purneftegaz (Table 3)[76,676 bytes].

Although outside investments are badly needed by the cash-strapped industry, in some cases the growing fear of losing operational and political control over Russia's biggest business has put a spoke in the oil privatization wheel. In particular, the state stake in Onako, which had been earmarked for sale this year, was actually blocked by the interested regional authorities until 1998. Also, state-paternalistic tendencies were embodied in a special government resolution of Nov. 23, 1996, which extended federal ownership of some vital petroleum industry assets until the end of 1998. Temporarily "protected" from complete privatization were Lukoil (for 6.6% of its equity), TNK (45%), Rosneft (51%), Slavneft (45%), VNK (51%), Onako (51%), Norsi Oil (45%), Komitek (21.7%), Transneft (51%), Sibur (51%), and Vostsibneftegaz (38%).

Still, driven by the starving budget, the federal government had to change its mind and, last May, received President Yeltsin's nod for lifting the ban on further privatization of Vostsibneftegaz, VNK, Sibur, TNK, Komitek, and Norsi Oil, which now may sell equity through forthcoming cash auctions.

Thus, despite temporary and negligible setbacks in the ongoing sell-off of the state oil property, privatization of this country's oil industry goes on with unprecedented speed and scope. Within the last 2 or 3 years, the bulk of the industry's assets are to be substantially privatized, with all the leading oil majors having already freed themselves from state control.

What is even more astonishing is that this hasty and all-out sell-off happens to the world's largest oil-producing industry, which has been a bulwark of the centrally planned economy for many a decade. As it was acutely commented by Russia's leading oil magazine, Neft i Kapital, "...the wave of 'destatization' raised by the first reformers in the time of Mikhail Gorbachev has turned into a real 'ninth wave' and has covered the peak that seemed unreachable in the old days."¹

New masters

On the surface, virtually all the recent megabuck acquisitions were made by previously unknown oil-related investment companies or groups (like Laguna, NFK, Interros Oil, Sins, Rifainoil, Monblan, and FNK) that were set up to bid for tendered state shares and to camouflage really involved interests. Still, it eventually became known that such ambitious commercial banks and nouveau riches as Uneximbank, Menatep Bank, SBS, and car magnate Boris Berezovsky had been standing behind the successful bids.

Thus, the ongoing privatization of Russia's oil has taken the form of its swift seizure by a handful of Russian banks, which have spent only a year to take over the biggest oil companies. In fact, directly or through affiliated companies and subsidiaries, Menatep Bank now controls 84.7% of Yukos's assets, Uneximbank 85% of Sidanco's equity, and SBS/Berezovsky no less than 99.3% of Sibneft's property.

Typically, the new owners began to exercise their controlling right for active interfering in the acquired company's affairs-even without waiting for final legalization of their acquisitions. Being more commercially motivated, the new managers insisted on substantial manpower cutoffs, shelving long-term investment programs, amputating marginal operations, and even terminating cooperation with foreign partners. These demands could not but cause frictions with the former sovereign bosses of the purchased oil companies.

In turn, Moscow-based oil marshals and provincial oil generals, anxious about retaining the challenged grip, are naturally more concerned about long-term stability and integrity of enterprises they see as their own. However, driven by the dire need of cash, they had to admit interweaving business interests and to accept the necessarily adjusted management mode-up to the introduction of oil companies' external management by banks and, finally, their own ousting by new managers.

Market-oriented and reformist oil managers welcomed the outside investors and allowed the banks' influence to grow. As a result, the most authoritative representatives of the emergent oil and money alliance have toppled the renewed oil management pyramids, which are still mostly cemented by immutable Soviet-type administrators. These administrators form a lower and almost impassable level of oil company hierarchy.

This massive lower-management layer, which was further solidified by retired ministerial bureaucrats, does not greatly vary in thickness from company to company, including the most progressive majors. Fortunately, this administrative layer is slowly displaced by younger, market-minded (and usually pretty westernized) employees representing a ground level of the present-day oil management structures. For the time being, it is the least influential level.

Such oil-hierarchy sandwiches-with the thin progressive bread around the thick conservative stuffing-are fairly common for both vertically integrated holding companies, most of which chose Moscow for their headquarters, and operating (oil producing, refining, and distributing) subsidiaries, which are usually located next to their main oil fields, refineries, and tank farms. Yet, due to definite cultural disadvantages of their provincial location, the former production associations led by tough oil generals are less exposed to market forces and better staffed with the inflexible administrators of yesterday.

Moreover, it is within subsidiary oil companies that operational control is concentrated and where the bulk of employees are paid (or often not paid) for providing everyday material support to an integrated oil company's activities. Hence, unless all the businesses have been consolidated, as in Lukoil, or a secondary market for distributed oil shares has developed, a typical oil subsidiary is controlled by the following groups of ordinary (voting) shareholders: a holding company's representatives (51%), the subsidiary's own administration (7%) and employees (13%), and outside investors (29%, including 4% reserved for national minorities of the North).

Divide and rule

Nevertheless, the best up-to-date oil directories on Russian oil encompass over 2,000 geological, producing, refining, transporting, distributing, trading, research, consulting, and service companies. But they cannot catch up with numerous newcomers and fail to provide any information about many publicity-shy businesses.

More than 110 companies (including majors' subsidiaries) are regularly reported as physically producing Russian oil, more than 50 are really involved in crude and condensate processing, and around 150 are systematically exporting Russian crude oil outside the former Soviet Union.

However, most of these trades are carried out by a handful of biggest oil companies. Taken together, the seven leading majors (Lukoil, Sidanco, Yukos, SNG, Sibneft, TNK, and Rosneft) currently account for about 65% of Russia's total oil production, 55% of the country's refinery throughput, and 50% of its crude oil exports to the "far abroad" (Table 4) [92,091 bytes].

Most of the new oil majors were designed as vertically integrated companies that would share regional markets along their technological chains and thus inherit territorial monopoly over the attached regional markets. Still, some of them lack the sought-for integrity and begin to compete with each other in the main refining and consuming areas.

In order to curb the growing competition in the most vital and profitable sphere of Russia's oil business, crude oil exports, the government had to distribute existing export outlets (pipelines and ports) among Russia's big oil sisters, which were appointed as coordinators of crude oil sales along assigned export routes. A recently redrafted coordination scheme, set out by the Ministry of Fuel and Energy in February 1997, made assignments for delivering and pricing crude oil destined for various locations, as follows:

• Lukoil-Lithuania, the Czech Republic, and Russia's port of Novorossiysk.
• Sidanco-Poland and Latvia's port of Ventspils.
• Yukos-Hungary, Ukraine's port of Odessa, and (in coordination with the ministry) the former Yugoslavia.
• SNG (assisted by Nafta Moskva)-Germany (including re-exports via its port of Rostok) and Novorossiysk.
• Sibneft-Russia's port of Tuapse.
• TNK-Tuapse and Ukraine's refineries at Odessa, Kherson, and Lisichansk.
• Rosneft-Novorossiysk and, under intergovernmental deals, Ukraine.
• Tatneft-Ukraine's refinery at Kremenchug.
• Slavneft-Slovakia (and, presumably, Belarus's refinery at Mozyr).
• VNK-Novorossiysk.
• Onako-Ventspils.

Toward world market

As new, production sharing contracts were introduced and the formerly unavoidable marriage with a local partner was no longer needed, Russian majors and their oil-producing subsidiaries started to claim sizable parts in large, foreign-backed projects in Sakhalin, Siberia, Timan-Pechora, and the Barents Sea, regardless of available finances, technology, and management skills.

The most ambitious and aggressive companies (like Lukoil, Yukos, Rosneft, Slavneft, and Tatneft) dared to risk their limited capital and reputation in the former Soviet republics as well as in Eastern Europe, North Africa, the Middle East, and even Latin America. Furthermore, to facilitate their penetration into the world oil trade, such internationally minded Russian majors as Lukoil, Yukos, and Sidanco have set up their own representations and trading firms in Geneva, Vienna, London, and other oil-related European capitals.

Still, the coming of the Russian majors to the international oil scene is greatly hindered by their financial weakness, while their competitiveness vis-a-vis foreign counterparts is seriously undermined by marginal economics of Russia's oil.

Moreover, the lack of democratic traditions, the absence of deeply rooted market mentality, and the predominance of state-paternalistic tendencies will definitely hamper the further shift of Russia's oil industry toward a highly competitive market. While the current hasty sell-off of state oil property is clearly compelled by the acute budget crisis, the ancient traditions of a centrally planned, command economy will probably induce the country's "petrolarchy" to set and follow its own, Eurasian, management paradigm-with tangible, Moscow-centric state control (and, surely, protectionism) from Moscow of the most vital spheres of the national oil business.

Initiatives to tighten federal control over the largely deregulated industry are being pushed by the Russian government.

One of them, incarnate in a couple of recent government resolutions, envisages restructuring of oil companies' tax arrears through special debt-for-share agreements concluded between taxation authorities and debtor companies before July 1, 1997. Under the scheme, debtor companies are given up to 5 years to pay off their tax debts. If they fail to return the debts in time, the federal government may take over 50% plus one share of their equity as collateral for overdue taxes.

The other renationalization initiative calls for creation of a Russian national oil company, RNNK, which would represent the state interests in oil production-sharing agreements, take care of oil-related foreign debts, supervise strategic petroleum reserves, and take under its trust all the remaining (and regained) state shares in other, semiprivate oil companies.

Acknowledgment

Reference

The Author

Eugene M. Khartukov is head of the World Energy Analysis & Forecasting Group (Gamper), professor of management and marketing at Moscow State University of International Relations, and general director of the International Center for Petroleum Business Studies, Moscow. Since 1984, he has advised and consulted on oil and gas economics and policies, energy pricing, and modeling to various Soviet/Russian ministries, international agencies, foreign governments, private oil and gas companies, consulting firms, and financial institutions. Khartukov received his PhD in international petroleum economics in 1980 from Moscow State University of International Relations, a post-doctorate degree in international energy economics in 1990, and a lifetime title of professor in 1994. He has authored and coauthored more than 170 articles, brochures, and books on petroleum and energy economics, management, and politics.

Copyright 1997 Oil & Gas Journal. All Rights Reserved.