Lukoil: It Takes Years To Build, Seconds To Break And Forever To Repair

| About: PJSC Lukoil (LUKOY)

Summary

The Russian energy industry successfully survived the energy crisis, coming out stronger.

Lukoil plays it safe: It sold its Kazakh stake to maintain margins and plans to sell its Swiss based trading unit Litasco as well as European based refineries it owns.

The company is further expanding into oil, holding discussions with Iran and Turkey. It also plans to keep investing in Siberia.

Lukoil is expanding into natural gas through its long-developing project in Uzbekistan.

Financials are healthy, but the company must address its operating margin. Possible tax regime changes relating to the energy industry would greatly benefit Lukoil.

Author's Note:

This article is part of the series called “Russia: Mapping and Benchmarking” and its purpose is to allow for a thorough understanding of the nation’s economy by analyzing its most relevant industries. The knowledge compiled can then be applied as a “benchmark” for analyzing any Russian company.

Check the image to understand the structure of the series. For more information also read the introduction of the previous article I wrote on Gazprom: “Gazprom: Russia’s Corporate Diamond.” In this article, we will be analyzing Lukoil (LUKOY). So let us enter the world of Vagit Alekperov and his industrial creation.

Note #1: Inside the article you will find certain numbers, ex.[#1]. These numbers are linked to supplementary material at the end of the article, “The Owl of Wisdom.” If you are interested in learning more about a particular subject that has a note attached to it, scroll to the bottom.

The meeting

The device on Putin's office started buzzing and his secretary informed him that Mr. Alekperov has arrived, “on time” - Vagit insisted that she should use these two words in her message.

(Putin) Ah, Vagit, it's nice to see you again. Been hearing some good news about Lukoil's stock price development.

Vagit sat across Putin, at the front desk where all the corporate meetings took place. Surprisingly enough, there were cookies and tea to be served. Last time he saw Alexei Miller, the message received was “the Kremlin’s corporate menu was blank.” I guess he did not like the cookies.

After exchanging a few words about the future of Russia’s energy Industry (Alekperov loved talking about this subject), Putin pushed for the formal meeting to begin. He lightly exhaled when he observed that Vagits dossier was overflowing with graphs and sheets - how surprising.

(Alekperov) Mr. President, there is so much to tell. I am confident that Lukoil will continue to show its resilience to market conditions and the unfavorable political context (he was used to being blunt but was always able to masterfully “coat” negative comments).

The Business and Porcupine West

Now, allow me to start by showing you the following graph:

As you can see, Lukoil is currently the second largest oil producer in Russia and owns 12% of our nation’s reserves. The company produces about 1.8 million barrels per day (2016), which covers 15%-17% of our nation’s total production (~10.8m, same year).

In 2016, we refined two-thirds of the oil we produced, but our refineries can process up to 90% of our current oil output. Of course Mr. President, the “unfavourable political context” (Alekperov insisted) has put our refining capabilities at risk.

As you can see from the graph, half our refining capacity is located outside Russia and if the U.S. decided to hurt us even more, it would try and target crude transportation to these regions.

Putin waved his hand at him, a sign that he wasn’t willing to discuss the matter. But he knew Vagit wouldn't give up that easily. Alekperov continued:

Moving on, in 2016, we produced about 20.3 bcm (billion cubic meters) of natural gas. We have been growing this business at a steady rate, since I personally believe that natural gas, as opposed to crude oil, will experience a higher demand. Alexei (Alexei Miller, CEO of Gazprom) must have informed you, that natural gas is used for the production of electricity and as many nations will move away from coal (excluding China), this raw material will have a vast market to cover. Bearing in mind the electric car revolution, if and when it happens, demand for more electricity will further increase demand for natural gas. Of course 40% of the gas we produced was sold to Gazprom. And of course our share in this energy product is still relatively insignificant, 20 bcm compared to Gazprom's 450 bcm in 2014 (relatively, because 20 bcm is about 65% of what Britain is producing). But, we are working on it.

What doesn’t kill you, makes you stronger

Mr. President, allow me to continue our discussion with Lukoil’s growth potential. Please, if you may, take a look at the following graph that I’ve constructed:

Section A (the upper three graph compilation) is meant to give us an idea about Russia’s crude oil business, its size and its advantages. As we can see in Graph A1, our nation ranks among the world's top producers.

We are also highly cost effective when it comes to crude oil production (Graph A2). And although Saudi Arabia, the UAE and other competitors have better margins, we have a major advantage when it comes to transportation: We are geographically closer to the EU, China, Turkey and Japan - although currently shipping rates and pipeline transportation costs are not that far apart.

Graph A3 reveals that the energy crisis “helped us” become more cost competitive. In 2015, we sold our 50% stake in a Kazakhstan field to China’s China Petroleum & Chemical (SNP) for $1.09 billion, to preserve our margins.

Section B proves why China will continue to be our focus for expanding our oil and gas trade volume. Graph B1 shows that China has an increasing interest in our energy business and Gazprom’s latest investments are further proof of that (Related article: Gazprom: Russia’s Corporate Diamond). Graph B2 and B3 are explaining the reason behind that interest:

China’s oil reserves are good for another 15 years, under current production levels. And those production levels are merely covering 40% of the nation’s current oil needs (2014 data). As for natural gas, the Asian giant does have plenty of reserves, but in unconventional form (shale gas). And since it is an agricultural nation, with 30% of the nation’s manpower being allocated to that sector which covers 9% of its GDP (9% is huge, since agri products are of low monetary value), the expansion of the shale industry will most likely be a last resort option (Related article: China: The Real Power Of The Dragon, Part II - 'A War For Independency').

So as you can see Mr. President, we do have plenty of growth potential. As for our expansionary policy, due to the “unfavorable political context” (and yet he said it again), I have been trying to minimize risk:

I have been selling our international gas stations and Lukoil’s new projects are always carefully addressed, by “sharing ownership” of these projects with other international energy companies [#1].

Alekperov proudly continued presenting the potential of his corporate child, as Vladimir Putin tried to avoid becoming overwhelmed with all the details. After a prolonged period of graphs and notes being thrown one on top of the other at his front desk, Putin tried to sum up Lukoil’s potential for long term growth:

(Putin) Vagit, from what I have come to understand so far, Lukoil has three major growth fronts:

(1) China, is the Company’s “next stop”, now that relations have heated up, after Gazprom and Rosneft promoted their interests there. Of course I understand your concerns that Xi Jinping will want to deal with government owned companies and not with a private ones like Lukoil, since we close deals “inter governmentally” for obvious reasons. But listen to this: Lukoil, as a private energy company, has the ability to circumvent western sanctions. This would allow China to flexibly use the company’s services. Also, since half of Lukoil’s refining capacity lies outside of Russia, you might want to consider expanding into Chinese refineries, even buying stakes at some of them. Remember, now that things are “warm” with the Chinese, we should promote as much expansion in Asia as possible.

(2) The EU, is where our major “competitive war” will take place, at a huge scale. The US is trying to penetrate the market, now that it lifted the policy that was not allowing it to export oil. It is also shipping LNG to Poland and other ex-Soviet nations. Lukoil needs to continue pushing competitors out of the market. Companies like Statoil (STO) already are feeling the pain.

But I read your notes on Saudi Aramco (ARMCO) being the real threat in the EU:

“The Maasvlakte Olie Terminal is one of the largest oil terminals in the world, serving the Amsterdam-Rotterdam-Antwerp ports that make up northwest Europe’s key oil hub (...) Saudi Aramco said the stake, which is thought to be for around one sixth of the terminal, would add to its current participation in other facilities in the same area, allowing for expanded offerings in the North west Europe refining hub” (Quote Source).

And Alexei (Miller) also informed me that Qatar is increasing its production of natural gas (LNG form) in collaboration with Western companies. Beware Vagit, do not lose market share or Gazprom (OGZPY) and Rosneft (RNFTF) will be affected as well. And you should also keep targeting Turkey. It has a vast population.

(3) Now Japan, is a very interesting market. From what you and Alexei have told me, we currently cover 8%-9% of the nation’s imports in both oil and gas. Your graphs also showed me that Saudi Arabia, the UAE, Qatar and Australia are our major competitors. Gazprom already is working on increasing LNG shipments to Japan via the Sakhalin Project (Japan is the largest importer of LNG, covering one-third of global imports). You Vagit, should better opt for selling more natural gas to Gazprom.

Concerning Japan’s oil needs, this graph you gave me was very interesting:

I wasn’t aware that Japan was generating up to 9% of its electricity by “burning” oil. It must be desperate for energy! Get ahead of your competitors Vagit, you have the upper hand on transportation costs. Just be aware of the risks involved, in case Japan’s hydrogen project succeeds. I have been informed that Kawasaki (KWHIY) and Obayashi (OBYCF) already are planning the first hydrogen powered energy plant.

Alekperov’s Notebook

(Alekperov) I shall look into these suggestions Mr. President. But for now, let me put you up to speed concerning the latest developments as well as refresh your memory on the most important ones of the past:

Newly gathered developments:

  • Chevron (NYSE:CVX) investment in Kazakhstan: Our company has a 5% stake at the Kazakh consortium (Chevron, Exxon Mobil (NYSE:XOM), KazMunaiGas, Lukoil). Chevron approved a $37 billion expansion that will increase the capacity by 260K barrels/day, added to the already 600K barrels/day capacity. The project will be completed by 2022 and the breakeven price is $50/barrel. Things look better for global oil prices and this should allow us to generate a minority interest profit - assuming that oil will maintain higher prices.

  • The CPC Pipeline and Sanctions: As well as crossing some 1,000km of Russian territory, the CPC pipeline is 31% owned by the Russian state (Kazakhstan and Chevron also hold stakes). Two sanctioned Russian companies, Rosneft and Lukoil, hold stakes. The huge Chevron Project in Kazakhstan uses this pipeline to send oil to the black sea. This could be a great opportunity to circumvent sanctions.
  • Iran Post-Sanctions Return: We hope to begin the development of two oil fields in Iran. Currently, Lukoil and NIOC are discussing the cost structure of the two projects. Before sanctions took effect, Lukoil operated the Anaran oil field in Iran.
  • Expanding to Turkey: We are in talks with Azerbaijan’s energy giant SOCAR concerning the joint acquisition of new assets in the fuel market of Turkey. SOCAR is wholly state-owned and our relationship from the past (SOCAR was under the control of the Soviet Union before 1991), should increase the likelihood of the project to move forward. Here is a graph of the Azerbaijani pipeline through Turkey, that we could benefit from ourselves (increase Market with limited capital investment funding required):

  • Sale of Diamond Unit: Lukoil completed the sale of its stake in the Arkhangelskgeoldobycha diamond mine to Otkritie Holding group for $1.45 billion in cash in May. Our profit before income tax from the sale was 48 billion roubles.
  • Otkritie Private Bank Bail-out: I read the central bank's statement concerning the “bail-out” of Otkritie Bank. I am pleased by this, since Lukoil had a stake in it.

Of course you are pleased Vagit, you have a stake in the Bank too, Putin thought. He realized that Alekperov and Lukoil are so much connected with the state, that they are risking losing the benefits of a private oil company - essentially being open to any future “sanctions attack,” thus greatly increasing the company’s contextual risk. This is not how he imagined Russia’s future to be. Unfortunately, many Russian businessmen that made their fortune out of the fall of the Soviet Union moved into the banking sector shortly after making their companies profitable. Now everything is linked to a relatively small group of businessmen. The same thing is happening to the US now, in different form.

  • Sale of Swiss trading unit, Litasco: We are processing the idea of selling our Swiss based trading unit Litasco, which was trading about 3.2 million barrels/day in 2016. Sanctions will make trading harder for Litasco and since the tax regime has not yet changed we could use the proceeds to expand our investments in Siberian fields.
  • Possible sale of Italian refinery: I have tried reducing the risk Lukoil faces when it comes to the location of its refineries. Our Italian refinery has the largest capacity outside of Russia and for the right price the proceeds can then be used to buy stakes in Chinese refineries. If Litasco goes (90% of the refined product was traded via Litasco), so should the Italian refinery.
  • Huge natural gas investment project in Uzbekistan: We continue our long-lived project in Uzbekistan. By the end of 2017 Lukoil will have invested $6 billion and after the completion of the next phase of the project, production in that nation alone will have reached 16 bcm (billion cubic meters). Here is a summary of the project's life:

Database, Past Developments:

  • ConocoPhillips’ exit (Collection Date: October, 2015): Allow me to remind you that ConocoPhillips sold its stake in Lukoil for $9.5 billion and subsequently exited the entire Russian market (Rosneft joint-venture project) after 25 years.

It takes years to build, seconds to break and forever to repair

Vladimir Putin had in the past spend a few afternoons with his economic advisors and Maksim (Maksim Oreshkin, Russia’s Minister of Economic Development) to come up with a set of data and metrics that when combined would summarize a company’s image from all basic perspectives. He didn’t need the in-depth details. Managing a nation is hard enough as it is.

He named this combined set of data and metrics the “Combo Graph.”

(Alekperov) Mr. President, I hope I haven’t “drowned” you with all the information by now. There is more to come (Vagit chuckled). I hope you are as excited as I am (no answer, not even a nod. Already prepared to learn more about my “baby.” That’s the spirit - Vagit thought, impatiently moving his legs around).

So Mr. President, here, this is the “Combo Graph” that Mr. Oreshkin told me you wanted prepared. I spared no detail:

To get started, allow me to briefly refresh both our memories on the purpose of this graph:

All the data presented are always of the past. This effectively means, that aside from spotting a trend (ex. in growth) and get a sense of the investments made to boost growth (cash flow statement, investment flows), the Combo Graph does not inform us on Lukoil’s future potential - that we covered in the previous sections.

It does however inform us on:

[a] the financial state of the company and whether it can take on investments if opportunities appear - via borrowing (a low debt/asset ratio is required) or by using its retained earnings (cash reserves must be available),

[b] and we also become aware of Lukoil's managerial team skills.

The latter is particularly important, because we can check how me and my management team did over the last years (turbulent periods are ideal to check on crisis management skills) and in comparison to our global peers. Now, Lukoil's stock price development indicates that I did pretty well, but let’s take things one at a time.

The Company Profile section of the Combo Graph includes Lukoil’s primary and secondary dependencies. By dependencies we mean important company model ingredients. When their values change, Lukoil will be affected either severely (primary dependencies) or modestly (secondary dependencies).

Of course crude oil price variations are affecting the company severely since oil is Lukoil's main product (crude and refined). Russia’s taxation system, specifically that relating to energy corporations, can also instantly affect the value of the company when altered. Imagine what a 10% tax reduction would mean for Lukoil’s operating and net profits - I cross my fingers Mr. President!

As for secondary dependencies, natural gas prices, geopolitical turmoil (sanctions) and severe currency swings (exchange rate hedging becomes difficult) are all important ingredients to keep in mind. We also should track the economic health of our trading partners. They are our clients after all.

Putin had started scribbling. He tried to update his “Tracking List” on Lukoil. He loved the old style pencil and leather booklet... "I keep telling me that lie," he thought. Although the iPad was nice and fancy (a gift from Maksim), he preferred to stay with what he knew. "I do the same with Russia’s economic model after all."

Moving on, the Stock Value section gives us an idea about the value the aggregate investment community assigns to Lukoil. In dollar and development terms, Lukoil has been “rated” higher when compared to both the average Russian energy company (RTS Oil and Gas) and the average large capitalization company (RTS Index). In rouble terms, Lukoil’s stock was in demand due to the depreciating rouble that allowed for a huge discount when bought using dollars, euros and yen.

As we have already discussed, I took the energy crisis and sanctions risks very seriously. I don’t exactly have the “backing of government coffers” like Alexei (Alekperov chuckled again to tone down his comment). And Mr. Market seems to be acknowledging that. Carefully going through the data presented inside the Brief Financial Statement Overview section of the Combo Graph, will allow us to verify my “caring” strategy in numbers and assess my managerial value.

That being said, allow me to start by explaining why revenues plunged in 2014. Well Mr. President, deteriorating oil prices were of course a major reason that caused the decline. Yet I also decided to sell Lukoil’s stake in a Kazakh gas firm to China's Sinopec in 2014/2015, in order to maintain the company’s margins. The sale reduced assets on the balance sheet accordingly, without trimming our debt as I worked to build up a safety stash of cash (due to the high contextual risk). Investors did not like the result this move had on the debt/asset ratio, which increased by nearly 30% in 2014 alone (see excerpt graph). But I had to act. As the graph denotes, our Asset Turnover ratio was negative and this meant that our existing assets were generating less revenues each year - and they still do, even after I decided to sell our Kazakh stake, our international gas stations, exit Iranian operations and reduce inventories.

Yes, coming out of the crisis Lukoil looks less promising than before. But my actions maintained our margins and even increased them slightly. Compared to Rosneft (RNFTF), Lukoil’s Gross Margin is higher. Our operating margin though is quite low, but at least me and my team managed to slightly improve it when compared to the five-year average. Unfortunately Statoil (STO), our main competitor in the EU market, maintains better margins against both Lukoil and Rosneft [#2].

Evaluating Lukoil

Alekperov leaned back in his chair and crossed his finger, patiently waiting for Vladimir Putin to contribute to the discussion. He wasn’t nervous. He thought himself as being the best when it comes to Russia’s energy industry. "Lukoil has been feeding the government's budget for years, with no direct help!"

Meanwhile Putin kept scribbling, crossing and drawing lines in his leather notebook. He kept Alekperov waiting, like he always did in every meeting. Gently passing his fingers through the "stocked" sheets like a good student, he stopped at the page that featured the title “the investors perspective.” Maksim had taught him well.

(Putin) Well Vagit, from what we have been discussing so far, Lukoil seems to have limited growth potential (short and mid term). Domestically, the tax regime is hindering Lukoil from investing more. Although you said that the company is planning to invest more into Siberia. The cash flow statements of the company show that since 2013, investments have been cut in half. A wise move I am sure.

So correct me if I am wrong, growth will only come from [a] the possible expansion into Iran and Turkey (via Azerbaijan), [b] investments into Siberia and [c] further increasing Lukoil's gas production, especially in Uzbekistan (an ~8% p.a. natural gas production growth rate has been evident in 2016). To my understanding, growth will be more relevant to middle eastern and international projects - excluding the prospects of a lower future tax rate for extracting oil.

Vagit started nodding his head up and down, like he was inside a moving car running over obstacles.

Now, in terms of Value, as you have mentioned investors think highly of your skills Vagit (Putin could hardly keep his lips straight. ‘This is amusing’). Lukoil’s share price has surpassed that of both the RTS Index and the RTS Oil and Gas specific index. Well done! But… (Alekperov gulped) this also means that investors will not think of Lukoil as a "value opportunity."

So although the Russian stock market is still undervalued and our economy turns into better days, a minor correction might still be in play. In this case Lukoil could witness a steeper decline. Temporarily, yes I agree Vagit.

Finally, when I look into the dividend payout, Lukoil’s yield ranges from 6% to 7%. I believe dividend investors would appreciate the level of the yield, particularly since you Vagit have worked to reduce risk for the company. You sold stakes in operations where you thought margins could get hit and you also consider selling Lukoil’s Swiss trading unit, Litasco, to avoid any implications relating to politics and sanctions. Careful steps indeed. Ideal for establishing a dividend stock reputation. But of course, you still need to keep in mind that many of Lukoil’s refineries are located outside of Russia. Those operations are not easily managed, if it comes to that.

In short then we have and he turned his booklet to show Alekperov his notes):

  • Growth Potential: Low (short term, due to the selling spree of most western related assets like Litasco, gas stations and EU refineries) and Medium (mid and long term, with the completion of the Uzbekistan project and the initiation of the Iranian and Turkish projects).
  • Value: Low to medium (until after the next Russian stock market correction or unless taxation rates are lowered or assets for sale reach a good price).
  • Dividend Value: High (might change if energy prices stay lower for too long, in which case Lukoil might have to cut back on payouts).

...which means Vagit, that the company is to become a "dividend and a tax cow." Music to my ears. You’ve successfully implemented Russia’s corporate plan, i.e. higher dividends and budget-based taxation. Alexei (Gazprom’s CEO) opposed this strategy, but you seem to have proven that it can be done and that it might even pay off - share price wise.

Now let me update my Tracking List, on issues that can greatly affect Lukoil in the future:

(On Developments - Growth Projects and Other):

-Investments

  • For the oil business, possible expansion into Iran and Turkey is of main interest.
  • For the natural gas business, the completion of the Uzbekistan project will affect capacity and hence revenues.

- Sales

  • Selling the Litasco business, might affect Lukoil’s revenue stream. But it would also decrease risk substantially and add to cash reserves.
  • Selling the Italian refinery (ISAB) again reduces risk, but at the same time the company’s refining capabilities decline. Selling a refined product brings in more profits than raw crude oil. Of course, the cash that will be gathered from both the Litasco and the ISAB sale, can be used to invest in Asian refineries - a great way to penetrate this Eastern market.

- Market Share

  • If Lukoil wanted to enter the Chinese and Japanese (and South Korean) markets, now is the time. The Western political system is in turmoil, China is in search for strategic partnerships to establish its leading Eurasian presence. And Japan is thirsty for energy. Any breakthroughs on the matter need to be closely watched (could transform Lukoil from a mere dividend stock into a growth stock at the same time).
  • Growing the company is of course important, but retaining its existing business is even more so. Saudi Arabia’s entry in northern Europe (which is to become the EU’s energy hub) is part of a widely organized strategy to minimize our energy supply monopoly in the region. With Qatar and the US both targeting the EU natural gas market, Russian companies need to collaborate as one front. Therefore, it would be wise to keep track on the number of shipments that reach Europe and come from Saudi Arabia, Qatar, the US and any other competitors. We should also check on Statoil’s new field discoveries that could increase the company’s output capabilities.

(On Financials - Turnover, Margins, Debt):

  • The Asset Turnover “readings” need to post positive values at some point. The energy crisis has partly been overcome (when it comes to crude oil) and low-margin assets have been “dumped.” If core assets still do not manage to show increasing revenue value, Lukoil could be in trouble. After all, you Vagit are only showing me broad Financial Statement data. I'm more in the dark and ratios matter to me and to investors. Constant negative releases do not build trust.
  • As for margins, maintaining current gross margin levels would do just fine. operating costs though need to be trimmed somewhat. Lukoil’s relating margin is consistently lower when compared to other Russian peers. Statoil's margins should be your benchmark Vagit. The company outperforms all Russian majors.
  • The debt/asset ratio also should be closely monitored. I’ve noticed that Lukoil is piling up cash reserves to protect working capital needs (we are still in crisis) and to be ready to invest if an opportunity reveals itself (in Iran, Turkey etc.). But a growing debt relatively to the value of assets, when combined with consistently negative asset turnover readings, does not look pretty to the average investor. It’s also about the company’s public image. Financial statements are Lukoil's prospectus, if you wish.

So I will keep a closer look on Lukoil’s Asset sales (Litasco, refineries) to see how they will affect the company’s financial statement readings. I shall do the same after each investment project has been completed (ex. Uzbekistan).

Energy Industry Evaluation: “Looking Good”

Soon after Vagit Alekperov left the office, Putin started connecting the dots. He wanted to have a holistic understanding of the energy industry. So he continued updating his notebook, but this time he tried to combine the information on Gazprom, Lukoil and the Russian Economy:

(Industry Relevant Developments - Potential of Industry):

  • Strategic international relations map: Energy is my nation’s main product. Exporting that product will allow Russia to expand faster and catch up with western nations (heavy industry and technological advances are needed). To serve that purpose, strategic alliances have to be established. We need to strengthen our economic relations with China and with Iran, so that we maintain a supply outpost in the Middle East (now that Saudi Arabia is expanding into Europe).

The Venezuelan crisis has so far served us well. Rosneft has been investing into the struggling nation’s oil sector. Venezuela has the largest oil reserves on earth, largely untapped. We will need to expand in order to increase our oil production capabilities.

As for Saudi Arabia and other OPEC members, we should maintain a neutral relationship status so that we can at least continue to cooperate and keep energy prices higher.

  • The lifting of sanctions: For sanctions to be lifted (partially), the Russian economy must strengthen. Reducing margins was a strategic success, but economic diversification is necessary. I should try and promote the weapons and metals industries and boost timber and coal trade.

From the political standpoint, the Nord Stream II project can either become a major win or a major defeat. If the project does move forward, it would be a huge blow for the US and Donald Tusk. It would effectively mean that the EU is moving against the superpower and Tusk would be sidelined. If however the project is halted for good, our energy industry would have difficulty expanding any further in Europe. The Nord Stream II is not just another project. It’s a turning point, a win or a defeat.

  • Domestic economy, less relevant: Although the domestic market is important (the Russian population is vast and the nation is linked to surrounding ex-soviet countries), the health of our trading partners and their tendency towards new forms of energy is where our attention should lie.
  • Taxation, if the US does it, so should we maybe: If I was to alter the taxation regime of the energy industry, I am sure that companies were to benefit. But I still have to take the government's budget needs into account. Government coffers are a valuable rescue tool in case a company needs to be privatized to avoid bankruptcy.
  • Financials and international competitiveness: Vagit was right to sell many assets that could deteriorate Lukoil's margins. He also was right to maintain cash reserves both in order to secure operating needs and to be able to invest in good opportunities. Co-venturing with other international corporations like Chevron is again a smart choice to circumvent sanctions. The industry seems to maintain strong margins, have limited debt and enough cash to protect itself from yet another crisis in oil and gas prices.

So it all comes down to sanctions, taxation and investment opportunities. And of course global energy prices and the EU/Chinese growth rates.

Let me also take a look at the Russian Energy Majors table that Oreshkin prepared for me. He selected companies with the largest capitalization. I can now use all the discussed information (Energy Industry, Gazprom, Lukoil) as a benchmark, in order to assess any other Russian energy company(hence the name “Mapping and Benchmarking” of our series):

*USD/RUB = November 2017, average price ($1/59 rubles)

**Seekingalpha tickers as presented in the table:^RNFTF^OGZPY^LUKOY^NOVKY^SGTPY^GZPFY^OAOFY^BNSFF

***Trailing Twelve Months (last 12 months).

I can also use the same benchmark info to assess any international energy company or industry.

I’m very pleased. Now I should better be heading for the Kremlin’s restaurant. Maxim (Oreshkin) is supposed to be waiting there, to prepare me for my meeting with metal producers.

The Owl of Wisdom, In-text supplementary notes for hungry minds

[1]. Lukoil’s international projects (2016)(Source): Most international exploration activities were concentrated in Iraq and Nigeria. A new oil field Eridu was discovered in Iraq (LUKOIL as a project operator and INPEX CORPORATION holding 60% and 40%, respectively).

In Nigeria, two oil deposits were discovered (LUKOIL – 18%, NNPC – 30%, Chevron as an operator – 22%, and ONG – 30%).

In Romania, 1,000 square kilometers of the Trident project seismic data were reinterpreted with the new drilling data to define the available resources and location of promising sites (LUKOIL as an operator – 72%, PanAtlantic).

[2]. Norway’s oil company taxation & Statoil: Norway’s government owns 67% of Statoil. Like in the case of Russia, Norway’s energy giant is being taxed heavily in order to cover budget needs. Aside from taxing corporate income at a 27% rate, an additional 51% resource extraction tax (on the exploration, development, and production of petroleum) is in effect (source). This is a heavy burden for Statoil and one of the main reasons that it incurs a loss, even though its margins (gross and operating) are far better than those of its Russian counterparts.

For example, operating margins:

Lukoil: ~7.4% Rosneft: ~10% Statoil: ~12%

And as we have already noted, Statoil’s gross margin also is much higher (better) than both Lukoil and Rosneft.

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