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WIKI ANALYSIS
"LUKOIL" is a vertically integrated Russian oil major that has the reserves and refining capabilities to compete with the largest oil companies in the world. Lukoil has recently seen vast variations in revenues from its refineries which are more vulnerable to the inherent volatility in the oil market. As a refiner, higher oil prices just mean higher costs and lower margins, a condition exacerbated by price-competitive nature of the refined petroleum industry. LUKOIL cannot pass the increasing input costs onto customers because they would simply move to a lower-priced refiner, so the company must deal with volatile margins - as seen by its recent revenue growth and simultaneous income decline. However, Lukoil's crude oil sales have stayed roughly flat, as they acquire companies to contend with decreasing proven reserves [1].
The majority of LUKOIL's exploratory operations occur in the Western Siberian region of Russia, where 60% of the country's oil and 90% of its natural gas reserves lay. While this affords the company a vast area of proven reserves to expand, it also means that the company is more heavily exposed to a maturing base. Western Siberia has been drilled for many years, and though it has a large quantity of oil under its surface, the speed at which the region is being exploited means that it will have a much shorter lifespan than other oil-rich regions with stricter production controls, like Saudi Arabia. LUKOIL has made efforts to acquire other exploratory companies in order to increase its reserves, since its own exploration has yielded fewer discoveries.
Russian oil infrastructure is controlled by state-owned conglomerates, and with the bureaucratic machine preventing efficient use of resources, they often create supply-chain bottlenecks that prevent oil companies like LUKOIL from being able to meet potential sales. However, the Russian state can also be a benefactor to LUKOIL, as it prefers to purchase its resources from domestic businesses. LUKOIL's position in the capitalist market puts it at risk of nationalization, as Russian leaders may decide that cheaper-than-market energy is more important to his country than the privatization of industry. On the international market, LUKOIL competes with the oil majors: Exxon Mobil, Chevron, Royal Dutch Shell, ConocoPhillips, and BP.
Business and Financials
LUKOIL is a vertically integrated oil and gas company, and was originally one of Russia's national oil companies though it is now entirely privately traded.
Fiscal Year 2010 Summary
In 2010, LUKOIL's net income was $9 billion, a 28.5% increase compared to the previous year, with sales revenues of $105 billion, an increase of 29.4% year-over-year. These increases were due to higher hydrocarbon prices, in addition to the appreciation of the ruble against the US dollar, which affected average realized prices in Russia.[2] During the year, LUKOIL's total hydrocarbon production available for sale reached 2.239 million BOE per day, a 1.2% increase year over year.[3]
Business Segments
Exploration and Production
LUKOIL's Exploration and Production segment entails exploration, development, and production operations, primarily located in Russia.
Refining, Marketing and Distribution
LUKOIL's Refining, Marketing and Distribution segment includes refining and transportation operations, as well as marketing and trading of gas, oil, and refined products.
Chemicals
LUKOIL's Chemicals segment includes processing and trading of petrochemical products.
Power Generation
LUKOIL's Power Generation segment includes generation and transportation of electricity, heat, and related services.
LUKOIL Owns Three of Its Own Export Terminals
LUKOIL owns and operates three major oil terminals: the Vysotsk terminal, the Varandey terminal, and the Izhevskoye terminal. Russia is the largest natural gas exporter and second largest oil exporter in the world[4]. LUKOIL uses its terminals to cut transportation costs when exporting its crude out of the country; it also makes money by allowing other oil companies to use the terminals to export their products.
Trends and Forces
LUKOIL Produces Mostly in One Region: Western Siberia
Estimates of Russia's oil reserves vary wildly, from 60 million barrels to 200 million barrels[5], though it is generally estimated that 60% of this is found in the Western Siberia region[6]. Furthermore, 90% of Russia's natural gas production and 72% of its natural gas reserves are found in Western Siberia[7] - an enormous amount considering Russia has the largest natural gas reserves in the world[8]. LUKOIL produced 63.7% of its crude oil for the first three quarters of 2007 in Western Siberia. With so much of its production centered in one region, LUKOIL is exposed to a few unique trends. In an attempt to diversify some of its production, on January 11, 2010 Lukoil and StatOil teamed up to drill in one of Iraq's largest fields, the West Qurna, thought to have 12.9 billion barrels of oil. StatOil would have a 25% stake in the venture while investing 1.4 billion dollars, while LukOil would own the remainder on a site where production could reach 1.8 million barrels a day. [9]
- Russian reserves are prone to short lives, as they are heavily produced. This is even more pronounced in Western Siberia, where most of Russia's production has occurred in the past. Though the region's reserves may be high-yielding in the short-term, fast depletion will hinder long-term regional production, especially as more and more international oil and gas producers enter the region. This can be illustrated by the organic decrease of 738 thousand tonnes of oil produced by LUKOIL's existing holdings in the region during the first three quarters of 2007 from the same period in 2006[10] (the company's overall production in the area increased due to acquisitions and new joint partnerships, rather than internal exploration and production).
- As old reserves in easily accessible parts of Western Siberia mature, LUKOIL must spend more on exploration for new wells, as well as on infrastructure to transport the oil to refineries and/or distribution centers. In the first three quarters of 2007, for example, the company's capital expenditures in the region rose $703 million from the same period in 2006 - more than the $632 million LUKOIL spent on exploration and infrastructure in regions that it had never developed before.[10]
- Western Siberia sees crude oil production taxes increase by $0.22 per barrel for every $1.00 that international Urals blend prices increase above $9.00 per barrel. However, when a given reserve reaches 80% depletion, this tax decreases by a factor of 0.035 for every 1% of the reserve depleted, allowing LUKOIL to spend more on using expensive technology to deplete the well as fully as possible. Essentially, this gives LUKOIL the ability to spend more on fully draining mature wells, increasing reserve life and offsetting the need for the company to engage in costly exploration.
Vagit Alekperov, president of LUKOIL, states that oil production in Russia will reach its peak in 2010-2011, and subsequently decline due to lack of enough incentive in geological exploration from the government, as expenses on new deposits discoveries are reimbursed only if proven successful. In addition, new fields are now signed away to the state rather than to a licensed holder, further discouraging exploration and resulting in a 65% decrease in geological exploration investments in 2010. Without government stimulating exploration, Alekperov says sustained oil and gas production will become difficult. Because LUKOIL produces so much in Russia, it will be adversely affected by a decline in oil production in the area.[11]
Gaibulla Abdullayev, head of Geology and Exploration of Oil and Gas deposits of the state-owned Uzbekneftegaz Company, states that foreign investment in exploration in Uzbekistan will reach over 1.9 billion dollars during 2010-2015. Among the foreign investors, the major companies interested include Lukoil, Gazprom, PetroAlliance and foreign CNPC International, China, Korea National Oil Corporation, South Korea and Petronas Carigali Overseas Malaysia.[12]
Railway Capacity is Blocking LUKOIL's Export Capacity Growth
In Russia, most petroleum transportation infrastructure is owned either by pipeline company Transneft or train company Russian Railways - both owned by the Russian state and both lacking the capacity to handle the all the natural gas and oil that is flowing out of the country. This capacity constraint prevents LUKOIL and other oil companies operating in Russia from being able to export oil as fast as they can, meaning the companies are losing potential export revenues. In LUKOIL's case, this has had a recent, material effect on its growth strategy; in October, 2007, the company canceled its plans to increase capacity at its Vysotsk terminal to 15 million barrels per year from the 12 million that the company expects to have shipped out of the port in 2007[13]. 3 million barrels of crude at the company's average Mediterranean market price of $63.96 for the first nine months of 2007 means that the company will lose about $192 million in potential revenue from the canceled Vostok expansion alone[14].
GDP Growth in the Former USSR Means LUKOIL is an Unwitting Player in an Economic Game of Russian Roulette
In 2007, Russia's GDP grew 8.1%, compared to the United States' 2.2% and China's 11.4%[15]. As a fast-growing, state-controlled capitalist economy, Russia's energy demand is also growing. This presents an opportunity for LUKOIL; as a state-controlled economy, Russia's government will give preference to Russian businesses when purchasing fuel and building power stations, and LUKOIL, as the largest privately-owned oil company in Russia, is positioned to benefit. The risk, however, is that the state may not want to pay the market price. Since LUKOIL is a publicly owned company, its executives are responsible to its shareholders, so they may not agree to sell oil at lower-than-market prices. In the present political climate, where President Vladmir Putin has near-authoritarian powers, LUKOIL is taking a significant risk. While Russia provides a great opportunity for shareholders, it's possible that going against the wishes of the Kremlin would lead to LUKOIL's nationalization, especially if the Russian state decides that it would prefer cheap energy and direct state income to foreign investment.
Rising Oil Prices Treat LUKOIL Worse that Most Vertically Integrated Oil Companies
Since around 98% of LUKOIL's revenues come from refining petroleum products, the company mainly sees the bad side of rising oil prices. Most of the oil majors are heavily exposed to the upstream side of the industry, so higher commodity costs benefit more than hurt them, but LUKOIL's sales balance causes the reverse to be true, as crude oil is a petroleum refinery's primary input, and if oil prices rise then margins shrink. Despite the fact that the company can sell itself its own oil, removing the value added costs that are driving prices up, LUKOIL does not produce enough crude to meet its refining capacity, and must purchase expensive oil from other upstream producers.
Oil and gas prices have fluctuated heavily over the past few years, though the trend in 2008 is a rise in prices, with a barrel of oil trading in international market a day after the new year at just over $100. Because both are nonrenewable forms of energy (they will eventually run out), slowing discoveries of new sources combined with increasing demand has led to rising prices - and to speculation that production is approaching peak oil quantities. Whether this is true or not, oil and gas are commodities: one company's oil can only be differentiated from another company's oil based on price. At the same time, refined petroleum products are also commodities. LUKOIL doesn't have the liberty to raise gasoline prices to pass the input costs on to customers because gasoline is a price-competitive product, so consumers would simply move to lower-price refiners. Fortunately for LUKOIL, however, the profitability of the current market for crude will drive increased exploration and production. If peak oil theory is just a myth, this should eventually cause production to rise and oil prices to fall.
Competition
In Russia, LUKOIL competes with state-owned heavyweight Gazprom. Other international companies involved in all aspects of the oil and gas industry (with a focus on refining) include:
- Valero - The largest independent refiner in the U.S., Valero has a total of 17 refineries with a capacity of 3.1 million BPD, and over 5,800 retail stations around the country[16].
- Sunoco - The second largest independent refiner in the U.S., Sunoco has a capacity of 950,000 BPD, with 5 refineries and almost 4,700 retail stations.
- The oil majors - Exxon Mobil, Chevron, RDS. BP, ConocoPhillips - All are vertically integrated oil companies that explore, extract, and refine petroleum products. Supplying their own oil allows them to keep margins down, while their immense size allows them to keep capital expenditures high to expand refining capacity and technology.
- Western Refining - Western Refining is the main supplier of refined petroleum to the Southwest United States, though the expansion of the Longhorn Pipeline threatens to shift this balance by enabling Gulf Coast refiners (like Chevron, Exxon, Valero, and Sunoco) to ship cheaper products into the Southwest distribution hub of El Paso.
| CONOCOPHILLIPS | ROYAL DUTCH SHELL | EXXONMOBIL | CHEVRON | BP | LUKOIL(1) | Eni S.p.A(1) | Total S.A. | |
|---|---|---|---|---|---|---|---|---|
| Reserves | ||||||||
| Oil and Gas Liquids (Millions of barrels) | 5,817[17][18] | 3775[19] | 7,576(2)[20] | 7,350[21] | 10,353[22] | 15,715[23] | 3,219[24] | 5,695[25] |
| Natural Gas (Billions of cubic feet) | 24,948[26] | 40,895[27] | 31,402(2)[20] | 23,075[21] | 45,208[22] | 27,921[28] | 18,090[24] | 26,218[25] |
| Production | ||||||||
| Oil and Gas Liquids (Thousand b/d) | 1,108[29] | 1,695[19] | 2,405[30] | 1,649[31] | 2,401[32] | 1,954[33] | 1,020[24] | 1,456[34] |
| Natural Gas (Million cf/d) | 4,970[29] | 8,595[27] | 9,095[30] | 5,125[31] | 8,334[32] | 1,586[35] | 4,114[24] | 4,837[34] |
(1) Latest data is for 2007 (2) Does not include reserves of equity affiliates
| SUNOCO | CHEVRON | VALERO | EXXON MOBIL | Royal Dutch Shell | SINOPEC | WESTERN REFINING | ConocoPhillips | BP | LUKOIL(1) | Eni S.p.A(1)[36] | Total S.A. | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Refinery Capacity (Million BPD) | 0.91[37] | 2.139[38] | 2.99[39] | 6.2[40] | 3.678[41] | 3.376[42] | 0.238[43] | 1.986[44] | 2.678[45] | 1.135[46][47] | 0.544 | 2.604[48] |
| Number of Refineries (including partial interests) | 5[49] | 18[38] | 16[50] | 37[40] | 40[51] | 17[52] | 4[53] | 12[44] | 17[45] | 9[54] | N/A | 25[48] |
| Number of Retail Gas Stations | 7,785[55] | 25,000[56][57] | 5,800[50] | 10,516[58] | 45,000[59] | 29,279[60] | 153[61] | 8,340[62] | 22,600[63] | 6,287[64] | 6,441 (in Europe) | 16,425[48] |
(1) Latest data is for 2007
Notes
- ↑ [1] Management Comments 2009
- ↑ 2010 LUKOIL Management's Discussion Pg. 17
- ↑ [2]
- ↑ Energy Information Administration: Russia: Background
- ↑ Wikipedia.com, Oil reserves: 2.7 Russia
- ↑ Oil of Russia: "BIG STEP FORWARD"
- ↑ Russia 2007, Slide 6
- ↑ Energy Information Administration: Russia: Background
- ↑ Norway oil firm teams with Russia's LukOil on large-scale Iraq deal January 11, 2010
- ↑ 10.0 10.1 "Management’s discussion and analysis of financial condition and results of operations" for the period ended September 30th, 2007
- ↑ Oil And Gas Production Will Start Declining After 2011: LUKoil Head
- ↑ Lukoil and Gazprom are among exploration investors in Uzbekistan
- ↑ PortWorld: "Lukoil cancels Vysotsk expansion"
- ↑ "Management’s discussion and analysis of financial condition and results of operations" for the period ended September 30th, 2007
- ↑ "List of countries by GDP (real) growth rate"
- ↑ VLO 4th Quarter and FY 2007 Earnings Release
- ↑ COP 2008 10-K, Item 8,Page 149
- ↑ COP 2008 10-K, Item 8,Page 152
- ↑ 19.0 19.1 RDS’A 2008 20-F, Supplementary Information, Crude oil and natural gas liquids
- ↑ 20.0 20.1 XOM 2008 10-K, Item 1, Page6
- ↑ 21.0 21.1 CVX 10-K 2009, Item 1, Page 7
- ↑ 22.0 22.1 BP 2008 20-F, Item 1, Page 16
- ↑ Lukoil Investor Relations – Fact Book 2008, Page 11
- ↑ 24.0 24.1 24.2 24.3 ENI S.p.A. – Fact Book 2007, Page 11
- ↑ 25.0 25.1 TOT 2008 20-F, Item 4, Page 10
- ↑ COP 2008 10-K, Item 8, Page 151
- ↑ 27.0 27.1 RDS’A 2008 20-F, Supplementary Information, Natural gas
- ↑ Lukoil Investor Relations – Fact Book 2008, Page 12
- ↑ 29.0 29.1 COP 2008 10-K, Item 6, Page 42
- ↑ 30.0 30.1 XOM, 2008 10-K, Item 6, Page 36
- ↑ 31.0 31.1 CVX 2008 10-K, Item 1, Page 5
- ↑ 32.0 32.1 BP 2008 20-F, Item 1, Page 14
- ↑ Lukoil Investor Relations – Fact Book 2008, Page 13
- ↑ 34.0 34.1 TOT 2008 20-F, Item 4, Page 12
- ↑ Lukoil Investor Relations – Fact Book 2008, Page 14
- ↑ E 2007 Annual Report
- ↑ SUN 2008 10-K, Item 7, Page 35
- ↑ 38.0 38.1 CVX 10-K 2009, Item 1, Page 24
- ↑ VLO 2008 10-K, Item 1, Page 3
- ↑ 40.0 40.1 XOM 2008 10-K, Item 6, Page 43
- ↑ RDS’A 2008 20-F, Results, Refining Data
- ↑ Sinopec Investor Relations, Operational Statistics for 2008
- ↑ WNR 2008 10-K, Item 7, Page 34
- ↑ 44.0 44.1 COP 2008 10-K, Item 1, Page 16
- ↑ 45.0 45.1 BP 2008 20-F, Item 1, Page 29
- ↑ Lukoil Investor Relations – Fact Book 2008, Page 15
- ↑ Conversion factor is 1 BPD = 50 tonnes per year
- ↑ 48.0 48.1 48.2 TOT 2008 20-F, Item 4, Page 36
- ↑ SUN 2008 10-K, Item 1, Page 1
- ↑ 50.0 50.1 VLO 10-K 2008, Item 1, Page 1
- ↑ RDS’A 2008 20-F, Results, Manufacturing
- ↑ Sinopec Refining Overview
- ↑ WNR 2008 10-K, Item 1, Page 19
- ↑ Lukoil Investor Relations – Fact Book 2008, Page 16
- ↑ SUN 2008 10-K, Item 1, Page7
- ↑ CVX 10-K 2008, Item 1, Page 25
- ↑ CVX 10-K 2008, Item 1, Page 26
- ↑ XOM 2008 10-K, Item 2, Page 25
- ↑ RDS’A 2008 20-F, Results, Marketing
- ↑ Sinopec 2008 Annual Report, Business Review and Prospects, Page 20
- ↑ WNR 2008 10-K, Item 1, Page 3
- ↑ COP 2008 10-K, Item 1, Page 18
- ↑ BP 2008 20-F, Item 1, Page 30
- ↑ Lukoil Investor Relations – Fact Book 2008, Page 60
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