LUKOIL (LUKOY)

• Article
• Discussion
• Edit
• History
• Bookmark

Bulls: Reasons To Buy Feeling Bullish? Be the first to explain why this would make a good investment Bears: Reasons To Sell Feeling Bearish? Be the first to explain why this would make a poor investment Send the authors a comment or suggestion I assume you mean Lukoil is now entirely PUBLICLY traded? [Dismiss] [Done] See All Suggestions

Top Contributors Avinash Gandhi Related Articles Exxon Mobil (XOM) ENI S.p.A. (E) ChevronTexaco (CVX) BP (BP) Commodities Prices

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. In the past year, LUKOIL has had 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.

[edit] Business and Financials

LUKOIL is a vertically integrated oil and gas company, and was originally one of Russia's national oil companies though now it is entirely privately traded.

LUKOIL's upstream segment has reserves of 20,360 million barrels of oil equivalent, making it the second largest hydrocarbon reserve holder after international oil major, Exxon Mobil; it owns 1.3% of the world's oil reserves and is responsible for 2.3% of the world's oil production.

The company's downstream segment has a refinery capacity of 58.1 tons per year, though it is significantly underutilized with 2006 production totaling just 48.9 million tons. Four of the company's seven refineries are in Russia, with the rest in Ukraine, Bulgaria, and Romania.

For the first three quarters of 2007, LUKOIL saw revenues of $57,347, with an operating income of $8,828, with revenues up from the same period in 2006's $51,803 but profits down from $8,863. Revenue increased due to higher production, but income decreased because oil prices for the period were volatile, but generally higher, causing some of the company's refining margins to shrink; given that the vast majority of its revenues come from downstream operations, the company could avoid shrinking margins despite the fact that most of the petroleum supplied to its refineries came from its own upstream segment.

20.6% of LUKOIL is owned by international oil major, ConocoPhillips; this ownership gives LUKOIL funding and joint venture opportunities with one of the largest oil companies in the world.

[edit] 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^[2]. 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.

[edit] Trends and Forces

[edit] LUKOIL Produces Mostly in One Region: Western Siberia

Estimates of Russia's oil reserves vary wildly, from 60 million barrels to 200 million barrels^[3], though it is generally estimated that 60% of this is found in the Western Siberia region^[4]. Furthermore, 90% of Russia's natural gas production and 72% of its natural gas reserves are found in Western Siberia^[5] - an enormous amount considering Russia has the largest natural gas reserves in the world^[6]. 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.

• 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^[7] (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^[8].
• 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.

[edit] 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^[9]. 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^[10].

[edit] 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%^[11]. 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.

[edit] 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.

[edit] 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^[12].
• 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.

[edit] Notes

1. ↑ OAO LUKOIL "INTERIM CONSOLIDATED FINANCIAL STATEMENTS, (prepared in accordance with US GAAP), As of and for the three and nine month periods ended September 30, 2007, {unaudited)
2. ↑ Energy Information Administration: Russia: Background
3. ↑ Wikipedia.com, Oil reserves: 2.7 Russia
4. ↑ Oil of Russia: "BIG STEP FORWARD"
5. ↑ Russia 2007, Slide 6
6. ↑ Energy Information Administration: Russia: Background
7. ↑ [http://www.lukoil.com/df.asp?id=17 "Management’s discussion and analysis of financial condition and results of operations" for the period ended September 30th, 2007]
8. ↑ [http://www.lukoil.com/df.asp?id=17 "Management’s discussion and analysis of financial condition and results of operations" for the period ended September 30th, 2007]
9. ↑ PortWorld: "Lukoil cancels Vysotsk expansion"
10. ↑ "Management’s discussion and analysis of financial condition and results of operations" for the period ended September 30th, 2007
11. ↑ "List of countries by GDP (real) growth rate"
12. ↑ VLO 4th Quarter and FY 2007 Earnings Release
13. ↑ COP 2007 10-K
14. ↑ RDS 2007 10-K
15. ↑ XOM 2007 10-K
16. ↑ CVX 2007 10-K
17. ↑ BP 2007 10-K
18. ↑ LUKOIL Company: General Information
19. ↑ E 2007 Annual Report
20. ↑ Total 2007 Results Press Release
21. ↑ SUN 2007 10-K
22. ↑ CVX 2007 10-K
23. ↑ VLO 2007 10-K
24. ↑ XOM 2007 10-K
25. ↑ RDS 2007 20-F
26. ↑ SHI 2006 Fact Sheet
27. ↑ WNR 2007 10-K
28. ↑ COP 2007 10-K
29. ↑ BP 2007 20-F
30. ↑ LUKOIL Company: General Information
31. ↑ E 2007 Annual Report
32. ↑ Total Website: "From Crude Oil to the Consumer"
33. ↑ Conversion factor is 1 BPD = 50 tonnes per year
34. ↑ Obtained by Dividing Total Throughput of 2.413 MMBPD by utilization rate of 89%
35. ↑ Sinopec Refining Overview