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Analysis: LUKoil in the Balkans

By CHRISTOPHER DELISO, UPI Business Correspondent   |   June 26, 2002 at 10:31 AM   |   Comments

SKOPJE, Macedonia, June 26 (UPI) -- It is a giant among oil companies, with the world's largest proven reserves (14.23 billion barrels). It operates in 25 countries, owns more than 2,600 gas stations worldwide, and accounts for 24 percent of Russia's oil production. Now LUKoil plans to storm Europe -- by way of the Balkans.

Lukoil's expansion in the Balkans is a microcosm of its worldwide plans. The Russian company seeks to capitalize on its strengths, while also addressing its weaknesses. No longer is it confining itself to scavenging off the carcasses of post-communist Eastern-bloc countries. Aggressive recent action in Greece, Cyprus and even Croatia reveals a new sense of confidence.

Although it has vast reserves of crude, LUKoil's refining capability is limited. Currently, it refines less than half of its 80 million tons annual crude output. Through the acquisition of refineries -- its major strategy in the Balkans since 1998 -- LUKoil hopes to boost this figure to 100m tons annually by 2005, reports Worldfuels.com.

These acquisitions are complementing needed organizational changes. The company has inspired pessimism among investors because of its lackluster annual growth rate (2 percent-3 percent).

Recently, company Vice President Leonid Fedoun revealed to the Financial Times LUKoil's main challenge: "We should not only be supplying crude oil, but also process and distribute oil products. We want to process up to 60 percent of our total oil at our refineries, compared with 40 percent now." Currently, LUKoil exports only 55 percent of its production, compared to 70 percent for Yukos, Russia's other oil giant.

Expanding the foreign distribution network is therefore key. Since the price at the pump in Russia is sometimes half of the world price, LUKoil has increased its acquisition of gas stations throughout Europe -- and even in the United States, where it currently owns 1,500.

In Romania, the company has plans to take over up to 250 gas stations over the next three years. LUKoil was also recently offered a 51 percent stake in Avanti, an Austrian retailer with more than 700 gas stations in Europe. Successful negotiations with Hungary's MOL could bring up to a five-fold increase in LUKoil's Polish gas stations. According to Interfax, the company also plans to acquire a major chain of gas stations in Bulgaria. A day earlier, LUKoil President Vagit Alekperov told ITAR-TASS about a recent tender victory for gas station development in Cyprus.

The Balkans is an attractive market. Transport prices are lower than in Western Europe, and forced privatization in many Balkan countries means great steals on refineries. LUKoil's strategy has generally been to scavenge the old and sick leftovers of the Soviet and Yugoslav countries. This started in 1998 in Romania, with the purchase of an 87 percent share in the Petrotel refinery. This $300 million deal was followed the next year in Bulgaria, with the acquisition of a 58 percent stake in Burgas' Neftochim refinery ($509 million). Also in 1999 the company picked up 51 percent of Ukraine's Odessa refinery, for $49 million.

Although these high-profile acquisitions -- complete with promises to invest -- seemed to guarantee future success, results have been slow. According to a FT report of May 29, the biggest headaches are in Romania, where Petrotel consistently loses money, "...because the market remains regulated with low prices and dominant state-owned companies." Here, Fedoun holds the Romanian government accountable for failing to come through on privatization promises.

The initial results in Bulgaria -- a $200 million loss in 1999 -- were equally disappointing. Although this was followed the next year by a $50m profit, some remain wary.

In March, the Greek government was warned by a group of international investors not to accept LUKoil's bid for a 23 percent share of Hellenic Petroleum. LUKoil had allegedly devalued the Neftochim refinery, by overcharging for crude oil and undercharging for refinery processing, reported The Russia Journal on March 1. LUKoil has reduced the value of Neftochim to less than $100 million, the investors charged, "while a comparable refinery in Poland is currently valued at $2 billion." In its defense, LUKoil pointed to the $200 million of debts that came along with Neftochim in 1999, and that $90 million of investments have been made since.

Despite these warnings, the Greeks did sell. The purchase fits LUKoil's general plans in southeastern Europe. The company is reportedly interested in a pipeline linking Bulgaria's Black Sea port of Burgas with Greece's Aegean port of Alexandroupoli. A joint venture of the Russians, Bulgarians and Greeks, the pipeline will cost more than $600 million and is set to be completed by 2007.

Farther south, LUKoil has moved aggressively into Cyprus. Besides winning the new tender for gas station development, LUKoil now controls 25 percent of the island's oil market.

Up in Macedonia, the Greeks have made major acquisitions in the banking, telecommunications, retail and oil sectors. In regards to the last, however, they may just be passing the torch to the Russians. Hellenic Petroleum purchased the state-owned Okta refinery in 1999, in a controversial deal that left Macedonians doubting the motives of their leaders.

It has been rumored that OKTA will be resold. But even if it is not, LUKoil's large stake in Hellenic Petroleum means that Macedonia too will fall under Russian influence.

LUKoil shows no signs of slowing down in the Balkans. The latest move is in Croatia, where the government is selling 25 percent of its oil and gas monopoly, INA, under privatization pressure from the World Bank and the International Monetary Fund. Some 20 international bidders -- including LUKoil -- are interested.

INA would seem to fit the LUKoil bill. It was a money-loser until just last year (when it turned a $44 million profit). But its two refineries will need some $360 million in investments through 2005, reported the FT on June 4.

In the end it may be worth it, however. INA has 450 gas stations in Croatia, and also a 16 percent share in Janaf, the state pipeline company. Janaf owns the Druzhba -- Adria pipeline, which provides key access to the Adriatic Sea.

LUKoil and INA's other suitors will have to wait a couple more weeks for the Croatian government to announce its shortlist. They will be cooling their heels much longer, however, where Poland's top refinery PKN Orlen is concerned. Here, the government is cautious, and talks are being postponed until 2003. Both Hungary's MOL and Austria's OMV are bidding for the 17.6 percent share of central Europe's largest refining group. Yet these companies are simultaneously actively soliciting INA. Their case will be weaker with the Croats, however, since the Polish postponement makes their future plans and capabilities uncertain.

This is not without irony. The Polish government's wariness -- basically, an understandable concern for getting a decent price -- has itself resulted from observing LUKoil's past Balkan buyouts. Yet since it is not vying for Poland's premier refinery, LUKoil is unaffected by the delay and thus stands a better chance in the Croatian bid.

To complete the coup, LUKoil will likely win in Poland, in a bid for 75 percent of the smaller Rafineria Gdanska. Thus would LUKoil prevent PKN Orlen from swallowing up Gdanska, which it reportedly would like to do.

Polish government opinion on the two deals differs remarkably, and seems to confirm the idea that LUKoil is on a lucky streak. Explaining the PKN Orlen postponement, officials have said the government doesn't take the deal for granted, but if LUKoil's expected bid comes in soon the Gdanska deal could be closed by the end of the year.

© 2002 United Press International, Inc. All Rights Reserved. Any reproduction, republication, redistribution and/or modification of any UPI content is expressly prohibited without UPI's prior written consent.
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