Houston-based ConocoPhillips announced earlier this week a $2.36 billion “strategic alliance” with Moscow-based OAO Lukoil under which Conoco will buy a 7.6% stake in the Russian oil company and get a share in joint projects. The deal provides Conoco access to Russia’s enormous but largely undeveloped oil and natural-gas reserves and opens a possible avenue for it to become the first Western petroleum producer to return to Iraq.
For energy producers looking to increase reserves, Russia represents one of the few places in the world where large reserves are available to private investors.The agreement will contribute to Conoco’s proved reserves and production, which are closely watched market measures of an oil and gas company’s prospects.
The move catapults Conoco ahead of most of the other major oil companies, which have have been largely unsuccessful in seeking a Russian partner. The deal also reflects the strong interest in Russia from foreign investors despite increasing concern over a recent Kremlin clampdown on political life and control over the energy industry. To ensure Conoco’s minority stake is protected, Lukoil agreed to give the company one seat on the 11-member board and change its corporate charter to require unanimous board approval of top corporate decisions.
Conoco plans to raise its stake to 10% by year end and to 20% within two to three years, which would cost about $3 billion at current prices. As Conoco’s stake rises, it would gain another board seat. This corporate governance arrangement addresses a problem that has tubed earlier Western investments in Russian oil and gas companies. For example, BP PLC sold its 7% ownership in Lukoil in 2001 because the stake was too small to have an effective voice in company decisions.
Although Lukoil was overshadowed in recent years by faster-growing Russian competitors such as Yukos, Lukoil is run by Russian oil and gas veterans, and its management maintains extraordinarily close ties with the Kremlin. That political stroke has come in handy lately since Yukos and its founder Mikhail Khodorkovsky ran into trouble with the Kremlin and Russian President Vladimir Putin last year, as related in these earlier posts. Those troubles scuttled Yukos’ negotiations with Exxon Mobil Corp. over a large investment in the Russian company.
The deal also gives Conoco an interest in Iraq’s vast oil fields. A part of the deal gives Conoco a 17.5% interest in a 1997 contract granted to a Lukoil-led group to develop Iraq’s West Qurna oil field, which is a major prospect with estimated reserves of 15 billion barrels. Although the contract was canceled just before the U.S.-led invasion in March 2003, all such Saddam Hussein-era contracts are currently being reviewed by Iraqi oil and gas officials.
Meanwhile, the stampede to gain a foothold in the Russian oil and gas market continued on other fronts this week as Royal Dutch/Shell Group executives met with Russian oil and gas officials in The Hague. Shell has recently expressed interest in a joint venture with OAO Gazprom, the big Russian natural-gas company. Those discussions have become more serious since Gazprom’s announced merger with Russian oil company OAO Rosneft, which will transform the company into a huge state-controlled oil and gas company.
Stephen Kotkin, a Princeton history professor who specializes in the business politics of Russia, analogizes doing business in Russia right now to a rugby scrum with market reformers, hard-line security advisers and members of Mr. Putin’s inner circle all wrestling for the upper hand in policy making. If market reforms are allowed to gain traction, then the rule of law will become established and likely supersede Russia’s notorious security apparatus. However, I remain skeptical that such reforms will take place so long as Mr. Putin remains in power.