Lukoil and the Kremlin

By Edwin Pestle, March 30, 2010

Lukoil company headquarters - Wikipedia Commons

Lukoil company headquarters - Wikipedia Commons

The Russian government may use a recent fatal accident involving the Lukoil security chief to get a tighter grip on the company – even though it is effectively already a state-controlled venture.

At first, all appeared under control. It was the Moscow morning rush hour on February 25. The black Mercedes S-500 with tinted windows carrying Anatoly Barkov, the security chief at Lukoil, had just sustained a head-on collision with a small Citroen C3 driven by 37-year-old Olga Alexandrina whose mother-in-law was sitting beside her. Both women were killed. The police who first arrived on the scene duly reported that the Citroen had crossed the median strip and was responsible for the crash. A Lukoil-affiliated radio station reported in its morning traffic report that Barkov had been the victim of an accident involving the company car and its driver.

Then the story began to unravel. Witnesses started calling morning traffic shows to say that the Mercedes, not the Citroen, crossed the median strip to avoid the traffic jam. If that were the case, the company driver would have only done so on his boss’s orders. Then it emerged, according to the Russian newspaper Vedomosti, that minutes after the crash, the Mercedes’s license plates with the number C398CC 77 had been removed (the plates with CC are typically only available to security services personnel). Witnesses called on by a non-profit motorist association said the Mercedes had a blue flashing light on top (they are banned for private cars), the use of which would also suggest that the driver meant to enter the opposite lane. Independent experts, examining footage taken after the crash, said it would have been impossible for the accident to have happened in the Mercedes’s lane. Still, the police, who are widely seen in Russia as easily persuadable when the wealthy are involved, refused to open an investigation. The lawyers for the women’s family hit a brick wall when they tried to obtain evidence. Most incredibly, the police said that no cameras clearly captured the stretch of road where the accident happened – this on a busy thoroughfare regularly used by the President and the Prime Minister on their way to the government airport Vnukovo-2. Lawyers for the women’s family counted at least 15 cameras in the general vicinity but said police would not let them see the footage.

At this point something unexpected happened. President Dmitry Medvedev announced that he had been closely following the aftermath of the crash and had ordered the head of the Interior Ministry to take the investigation into his own hands. Tinted-window limousines with illegal flashing lights drive into oncoming traffic on a daily basis in Moscow, so nothing about the case itself makes it unusual. Lukoil had clearly been selected for special treatment by the government.

No mercy
For Lukoil, this was only the latest shock in what is a painfully one-sided relationship with the state. Since the YUKOS affair in 2003-04, the company has gone out of its way to show that it is a tax-paying, Kremlin-friendly outfit with no interest in politics. It participates in all of the Kremlin’s petro-political ventures abroad, which typically involve uneconomical projects with sizeable upfront investments but with unclear payouts in countries like Venezuela. With the government’s encouragement, it rushed to buy downstream assets in Western Europe at the peak of their valuations. Other companies privately complain that Lukoil will not join them in lobbying for the revamp of the punitive Russian oil tax system.

Yet Lukoil has gotten nothing back for its troubles. The company has been shut out of bidding for lucrative licenses in the tax-preferential regions of Russia. Its last major project, the South Khylchuyu field – a joint venture with ConocoPhillips – never did get the hoped-for export duty holidays (export duty is the largest single cost item for Russian oil companies, and is equal to almost half of the entire revenue per barrel). As a result, the field’s lifetime return on investment is estimated by one investment bank at around 4%, lower than what Lukoil pays to borrow money and finance the investment: in other words, the project is loss-making. The two complex fields that Lukoil is developing in the offshore Caspian have not been granted the export duty holiday either, even though one of them is due to be launched within two months. As a result, their returns may barely cover the cost of financing.

When the Finance Ministry threatened to take away the export duty break for Rosneft’s Vankor field, that company’s CEO uncompromisingly said that in the event of there being no tax breaks, the state-controlled Rosneft would stop all additional investments in the field and cut the planned production in half. It is impossible to imagine that Lukoil’s CEO, Vagit Alekperov, would allow himself to make such a statement. Foreign institutional investors were bowled over in February when Lukoil executives announced at a private meeting: “We’re a private company with a government mindset.” That would be the worst of both worlds – a company that neither enjoys special privileges because it’s private nor allocates capital efficiently because it has something other than a profit motive on its mind.

In March, Conoco announced that it would sell half of its 20% stake in Lukoil because decent opportunities for joint work had not materialized. “The largest strategic opportunities have been reserved for [government]-owned Russian companies,” CEO Jim Mulva told the FT. This amounts to saying that Conoco picked the wrong company as its entryway to Russia.

Lukoil has itself admitted that it has passed the growth stage of development, and most analysts expect it to struggle to maintain even flat oil production. Yet, as investment tapers off, the company has been reluctant to increase dividends. In a telling aside, Leonid Fedun, a vice-president at the company, said at the investor day in late March that Lukoil is wary of purchasing the stake that Conoco is selling because “it could be taken extremely negatively by the political leadership, considering that we have investments to make.” Yet the Russian political leadership has left Lukoil with no profitable investment prospects either at home or abroad.

Bite worse than bark
Until now, though, the Kremlin has had no excuse to bear down on the company. That is why the Russian President’s interference in the Barkov incident could be worrying for the company. As head of corporate security, Barkov would know everything about the inner workings of Lukoil. If an investigation finds that there was an attempt at a cover-up following the accident, then the government would likely raid the company and seize Barkov’s files. There is no telling where this might lead.

In hindsight, Lukoil should have immediately sacked Barkov – not for the accident itself, but for the perception of a cover-up. What it probably did not foresee, accustomed as it is to kowtowing exclusively to the powerful, was the tumult that the crash would provoke among the impuissant. Nor did they foresee the fact that the tumult – sustained as it was by state-owned channels reporting on the collision and its aftermath and openly questioning Lukoil’s version of events – would be tolerated, if not encouraged, by the government itself. Now, by continuing to retain Barkov, Lukoil is exposing the company to its employee’s problems.

The government, in short, has managed to put the company in check once again. Lukoil’s hope now is that the Kremlin will have no need to go for checkmate against “a private company with a government mindset.”

30 March 2010

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