Russian Oil for the Welfare of Russia

PERHAPS YOU HAVE heard of a Russian oil company called OAO Oil and Gas Co. RussNeft. Until recently, RussNeft was an independent, vertically integrated oil holding company that ranked among the top 10 oil and gas enterprises of Russia. Despite the similarity of names, RussNeft is not to be confused with the state-owned oil company Rosneft.

RussNeft and Its Oil Output

In recent months, RussNeft has lifted and delivered about 3% of total Russian oil output. The oil reserves of RussNeft (or what the Russians call the “net effective pay”) are estimated to exceed 630 million tons (about 4.6 billion barrels, using a conversion factor of 7.3 barrels per ton), and its annual oil production is near 17 million tons (about 124 million barrels per year). RussNeft’s oil output translates into about 324,000 barrels per day, or, by comparison, slightly more than 40% of the total daily oil output of Alaska’s North Slope. And by way of further comparison, the daily worldwide oil output of a well-regarded Western independent oil company such as Anadarko Petroleum is about 190,000 barrels per day (110,000 from the U.S. Gulf of Mexico and 80,000 from overseas operations). So RussNeft is quite a bit larger than Anadarko, and a significant player in the Russian oil business by any measure.

For all its size and scope, RussNeft is a new player in the Russian oil industry and began its existence in September 2002. The company is what one might characterize as a roll-up, meaning a series of acquisitions to a core entity. Under the control of company president Mikhail Gutseriev, in 2002 and 2003, RussNeft acquired numerous upstream, oil-producing assets across Russia’s vast landscape. During the second stage of its development, in 2004, RussNeft integrated its newly acquired assets into a unified production structure. In 2004 alone, RussNeft’s oil output quintupled, and the firm became one of the top 10 oil majors in Russia. In 2005, RussNeft became vertically integrated with its acquisition of several refining and marketing properties, and has been aggressively upgrading its refineries to world standards. In 2006 RussNeft stabilized its oil extraction operations. It began to ramp up for an intensive drilling program in 2007, intending to increase its reserves. Thus, the past five years have been a time of rapid and outwardly enviable growth for the company.

RussNeft currently employs over 17,000 workers and runs 30 producing plants, two refineries, a transport plant, and a state-of-the-art distribution network of 311 retail filling stations that sell about 9% of the motor fuel distributed in Russia. The company’s facilities are located in 23 regions of Russia and the Confederation of Independent States (CIS). Within Russia, RussNeft is engaged in what it characterizes in its press releases as “large-scale social and charitable programs based on agreements with the administrative bodies of the subjects of the federation.”

According to a statement by company president Gutseriev:

“Our RussNeft is the youngest company among Russian vertically integrated oil companies, which operate at Russian and world crude oil markets. We are just beginning to talk about ourselves, our plans, and development trends. But the most important thing is that we are sure that in the nearest future, we shall be able to take up a leading position and be among the leaders of the domestic fuel-energy complex.”

So up to now, RussNeft has demonstrated and exuded an aura of confidence as to its place in Russia’s energy future, or what Mr. Gutseriev calls its fuel-energy complex. And on its Web site, RussNeft announces prominently that its goal is “Russian oil for the welfare of Russia.” But that is, apparently, not good enough.

Not Good Enough?

On July 30, 2007, the board of directors of RussNeft issued a translated press release announcing that it has “approved Mikhail Gutseriev’s declaration about deliberate laying down of the power of the president of oil and gas company RussNeft.”

Gutseriev later issued a statement saying that he was quitting the oil company and selling his shares, citing “unprecedented persecution” by the authorities. Gutseriev also said that the persecution by Russian officials was in the form of multiple inquiries by tax authorities, the prosecutor general’s office, and the interior ministry. Gutseriev said that he would retire to the countryside “to conduct scientific and technical research.”

Arresting All the Shares

And on July 31, 2007, Moscow’s Lefortovo (the shorthand term for Russia’s Ministry of Justice, interestingly named after the former Soviet secret police prison) issued a statement that it had officially “approved the request to arrest 100% of the shares of [RussNeft].” The request for seizure of RussNeft shares was made by the ministry in relation to a criminal case against RussNeft’s former chief executive Mikhail Gutseriev for tax evasion and what were termed “illegal business activities,” according to the Russian statement.

On Aug. 8, the Justice Ministry followed up with an announcement that “The shares [of RussNeft] have now been seized.” (There is an eerie semantic parallel here to the words of the Soviet pilot of a Sukhoi-15 interceptor aircraft who shot down a Boeing 747 Korean Air Lines Flight 007 on Sept. 1, 1983. After shooting down the Boeing, the Soviet Su-15 pilot radioed to his ground controllers, “The target has been destroyed.”)

We Predicted This

In an earlier report, Whiskey & Gunpowder predicted this course of events for RussNeft. We wrote:

“Unlike many other Russian businessmen, Gutseriev does not owe his success to ties with the Kremlin. In fact, he is neither a friend of Putin’s inner circle nor the pawn of a larger Russian oligarch. Gutseriev’s secret is foreign support in the form of Glencore, the Swiss-based resources-trading firm founded by the infamous American power peddler (and Bill Clinton pardonee) Marc Rich. It was Glencore that supplied Gutseriev with the majority of the financing he needed to build RussNeft into the firm it is today.”

We also wrote:

“RussNeft appears about ready to be swallowed by Rosneft, in part because Gutseriev had the temerity to challenge Rosneft for the ownership of some assets Rosneft was seeking. Those clashes ended Gutseriev’s ability to fly under the Kremlin’s radar, and now he — and RussNeft — is squarely in the Kremlin’s sights.”

According to one press report from AFX News Ltd., a Russian concern called Basic Element, the holding company of Kremlin-friendly tycoon Oleg Deripaska, has stated that it has requested of the Russian federal anti-monopoly committee for RussNeft to be absorbed into its energy subsidiary. But this is not yet a fait accompli.

In the past two years, the Russian government has steadily extended its reach over the country’s energy industry. The Russian Federation has built its state companies into major global players. Originally, the logic for the expansion of state control was basically nationalist, coupled with elements of the Byzantine political culture that has been part of Russia for many centuries. As part of the motivation, Russian power players were incensed that oligarchs (and, even worse, foreign corporate entities such as Shell or BP) were able to profit from private ownership of the country’s oil wealth. Thus, by consolidating within the “fuel-energy complex,” the Kremlin gained access to a powerful tool for influencing the Russian people at home, the nations of Russia’s near-abroad, and, by implication, the behavior of the European states further downstream.

But now there is a new logic in the nationalization process: political competition. Within Russian President Vladimir Putin’s inner circle, there are two power centers. The first power center, comprising First Deputy Prime Minister Dmitry Medvedev and Deputy Chief of Staff Vladislav Surkov, is the power behind Gazprom, which is the Russian state-owned natural gas mammoth. The second power center, comprising Defense Minister Sergei Ivanov and his colleague Igor Sechin, controls Rosneft, Russia’s major state oil firm.

The Gazprom and Rosneft teams are more than simply two adversarial state companies, competing for business like, say, Exxon Mobil and Chevron in the West. Gazprom and Rosneft are representative of the two factions struggling to succeed Mr. Putin as Russia’s next president, with Medvedev and Ivanov as the candidates and Surkov and Sechin as the powers behind the throne. For these two teams, the competition for resources between Gazprom and Rosneft is more than simple one-upmanship. This not-so-friendly competition is the most clear-cut and public means of evaluating who is doing better at consolidating power in the critical energy sector of the Russian economy and who will be selected (not elected) as the next president of Russia in March 2008.

Thus the slogan “Russian oil for the welfare of Russia” takes on an entirely new meaning. And it is not good to be standing in the way of the ongoing consolidation within the Russian “fuel-energy complex.”

Until we meet again…
Byron W. King

August 10, 2007