Russneft falls foul of Kremlin's strategic oil cut-off

By bne IntelliNews June 18, 2007

Tim Gosling and Ben Aris -

The fast growing independent oil company Russneft has fallen foul of the Kremlin by growing too fast. The company has been under attack and could lose its licenses because it has made the mistake of producing more than 100,000 barrels a day (b/d).

The Kremlin is currently debating a law that would define which of Russia's sectors are "strategic" - an appellation that can land investors into trouble, as the state has made clear its intention to renationalise at least part of companies in these sectors.

The cabinet came close to signing off on a list of 11 sectors in February, but the list was withdrawn at the last minute, reportedly because of pressure from the FSB – successor to the KGB - and the hardline security services faction in the Kremlin, which currently is seen as having gained the upper hand amongst Russia's political elite. The rumour is that the so-called siloviki are holding out for a list that includes over 40 sectors. Analysts don't expect the issue to be resolved until after the presidential elections slated for next March.

Nevertheless, oil was clearly always going to be on the list. The issue is only how big does an oil company have to be to count as strategic?

The working assumption had been that small companies will be left alone, while the Kremlin will retake control of the big companies such as Yukos, which has been bankrupted and most of its assets sold off in rigged auctions to state-owned oil sector champion Rosneft.

Russneft, which was founded by the former head of state-owned oil company Slavneft, Mikhail Gutseriyev, was considered small enough to come under the radar. Slavneft was the last state-owned oil company to be sold to Sibneft in December 2002, just before the tide of oil sector privatisations turned into a re-nationalisation effort.

However, recent attacks by the tax authorities on Russneft suggest the threshold of what counts as strategic in the oil sector has been drawn at the very low level of 100,000 b/d.

Too big for its barrel

On June 13, the Federal Tax Service announced eight lawsuits, originally filed in April, against past and current stakeholders in Russneft over share sales, targeting a total of 11 Russneft subsidiaries. According to a spokesperson for the authorities, "the founders of Russneft have scattered the company's shares through a long scheme of sale-purchase agreements, which have contradicted the basic principles of law order and good morals."

In December, Gutseriyev told reporters that he owns 70% of the company, with the remainder held by "relatives."

The Federal Tax Service is now demanding cancellation of these transactions in the Moscow Arbitration Court. Although the court has said no action is currently underway because of technical flaws in the charges, if it's decided that Russneft acted with malicious intent, the state could confiscate the shares. Last month, the Financial Times quoted a source close to Rosneft as saying that his company is "extremely ambitious in regard to [Russneft's] assets."

Chris Weafer, head of reserach at Alfa Bank, says it's hard to see any other result than Rosneft's eventual absorption of its smaller rival via auction.

The case highlights Russneft's dance steps with the devil over the last half decade, with the company looking likely to lose its assets in much the same way that it gained many of them in the first place. The blistering pace of Russneft's rise - breaking into the top 10 of Russian oil producers just a couple of years after it's inception in 2003 - undoubtedly owed much to patronage from on high, secured by Gutseriyev and his Slavneft chums.

"I have the sense of benediction from above," Eric Kraus, head of equities at Sovlink Securities, told The Moscow Times in 2005, as the company built its portfolio of 30 production companies. "The Russian government and the powers that be may be seeking to bring about a consolidation of small and inefficient companies."

Funds from the Swiss-based commodities trader Glencore powered the Russneft shopping cart as it steered around the country picking small assets off the shelf and building up capacity from the roughly 100,000 b/d when the tax authorities' began investigating the firm to the 300,000 b/d of today. Many of those assets were picked up at discount prices - such as six fields in the Tomsk Region bought in 2004 from Tomskneftegazgeologiya VNK as it faced pressure from tax authorities. The most controversial purchase was of Yukos' 50% stake in Zapadno-Malobalyk in 2005.

Unfortunately for Russneft, the powers that be, and the game, changed not long after. Since then, the acquisitions and the constant boasts of an impending IPO appear to have pretty much dried up.

"Russneft had strong support in government, but probably from mid-level," Weafer suggests. "But then Rosneft started building, the heavyweights got interested and the support dried up very quickly."

The first move came in November, with criminal cases brought against managers at three Russneft units – ANGG, Ulyanovskneft and Nafta-Ulyanovsk – over the sale of $300m of crude that was allegedly pumped in excess of the permitted amount. Then, January saw Russneft's offices raided, apparently over suspicions of tax fraud. Last month saw Gutseriyev charged with, "illegal activities committed by an organized group on a grand scale," according to an Interior Ministry statement, although Gutseriyev denies he's been charged.

The company is a victim of its own success, it seems. It simply grew too big and at the wrong time, making it a prime target for what Weafer suggests is a year dedicated to "tidying up" the energy industry. Perhaps not coincidentally, Weafer notes that following Rosneft's capture of Yukos' assets over the past few months, taking on Russneft's capacity as well as would push the state giant past its declared first-stage output target of 2.5m b/d, "without even digging a hole in the ground."

"Sakhalin-2, TNK-BP and Kovykta, SurgutNeftgaz, the pressure on Lukoil - they're all just part of tidying up," Weafer says, dismissing theories linking the fall of Russneft to reactive moves, ie. rumours of displeasure in the Kremlin over the Yukos acquisition, the backing of a large US fund, talk of political activity, or even a longer-term strategy allowing Russneft to do the spade work in consolidating the many scattered assets it holds.

"Now the core of the industry is established in the state holdings, this is the year for the final round," Weafer says. "And I think the Kremlin wants the process completed by the time Putin leaves. Then the new president can concentrate on allocating new licences, development and investment. All the small but significant independent producers are going to get mopped up - anyone producing 100,000-150,000 b/d."

News since the completion of the Yukos auctions certainly supports such speculation, with numerous companies - previously thought to be under the Kremlin's "strategic assets" radar - finding themselves prodded by the two frontline government prongs.

Imperial Energy and Urals Energy have both been trying to ward off jabs from Oleg Mitvol, the head of the environment agency Rosprirodnadzor, while Bashkir faces a similar situation to Russneft. Lukoil, meanwhile, thought to be the elected representative of the "independent" sector in the Kremlin model, is finding itself increasingly coming under the thumb.

"By the end of the year, I expect we'll have a much cleaner and more consolidated structure," Weafer says, pointing out that this same process is ongoing in all of Russia's strategic industries. "It's just that oil and gas is the furthest along the path."

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