FPRI BEAR MARKETS BRIEF: Cool Hand Lukoil: Alekperov knows when to fold em’

FPRI BEAR MARKETS BRIEF:  Cool Hand Lukoil: Alekperov knows when to fold em’
Russian oil major Lukoil has become an investors' darling, but might be in the sights of state owned oil major Rosneft / wikicommons
By Nicholas Trickett in London April 3, 2018

bnePeople Russia Lukoil CEO Vagit Alekperov kremlin.ru -2

Russia's largest privately owned oil company Lukoil's CEO Vagit Alekperov spoke with TASS on March 28 and had this to say: “Every director of a company should think about how a company can work effectively after he’s left an operational position. Today, the functions of management and shareholders are united, myself and (vice-president) Leonid Fedun. The time is coming to separate these functions. We don’t intend to cancel the listing. It’s never been our goal to create a private company.”

The announcement hasn’t made headway in English-language outlets, likely due to other, more pressing stories in the wake of Putin’s re-election. But Alekperov’s statement is a telling symbol of what to expect for Russia’s energy sector and elites under Putin 4.0, and a rather damning one that cuts a strong contrast between him and the gray cardinal of Russia’s black gold: Igor Sechin.

The Last Great Oiligarch

Alekperov has been in the oil and gas sector his whole professional life, working as a driller before climbing his way to being an engineer and, at the age of 29, a manager at Surgutneftegaz. He headed Povkhneft from 1983 to 1985, worked as Deputy General Director of Bashneft for two years (note the company), and then worked his way up the Soviet Union’s ministerial system until he became deputy minister of the USSR’s oil structures in 1990. It was a launching pad that eventually landed him the opportunity to start his own firm – Lukoil – in 1991 by taking three oilfields controlled by the Oil Ministry.

Since then, he’s steered Lukoil to play a big role in Russia’s energy sector. The company now produces over 1.7 million barrels of oil per day and, most importantly, plays a leading role in Russia’s oil strategy in Iraq and Iran. This last week, Lukoil overtook both Gazprom and Rosneft by capital valuation, backed by promises on management’s part to use extra revenues earned when oil sits above $50 a barrel to pay investors. Though expected to be short-lived, the valuation was testament to the company’s management compared to its state-owned competitors.

Alekperov has charted a steady strategic course for the company that is sustainable and conservative. The company is set to invest $8 billion a year for the next decade, banking on domestic tax reforms to help it pursue developing unconventional reserves. It aims to invest 20% of that annual $8 billion abroad, mostly into Iraq, Mexico, and Iran when possible. Alekperov’s rise, management, and strategy starkly contrast with that of Rosneft CEO Igor Sechin.

Darth Vader’s Imperial March

Sometimes called Russia’s Darth Vader, Sechin got his political start as Putin’s secretary after he was named deputy mayor of St. Petersburg. His ability to control information, size up those coming in and out of Putin’s orbit, and loyalty to Putin and the state earned him a role as a deputy in Putin’s first presidential administration. He was given an energy issue portfolio alongside security and steadily rose up the ranks until he was made CEO of Rosneft in 2012.

Sechin is known for his absolute fealty to Putin and for his ceaselessly aggressive style, one that generally rubs people the wrong way. Since he’s stepped into the role of CEO, he bought out TNK-BP in 2013 using $70 billion in financing procured from China’s CNPC and Chinese banks. He didn’t sell them any major assets in return. The move made Rosneft the world’s largest publicly traded oil company by output.

Since then, he’s raided assets whenever possible and made himself the tip of the spear for Russia’s attempts to pivot to Asia-Pacific oil markets and break out of the limits imposed by sanctions on energy projects post-Crimea. Sechin’s aggression has won Rosneft 49% of a large refinery in India’s Gujarat due to Essar Oil’s heavy debt load, a series of deals with CEFC China Energy that have single-handedly reduced the quality of crude flows to Europe due to redirected oil volumes, and prime assets in Venezuela’s debt-laden oil and gas sector using its leverage.

He even managed to convince the Kremlin to “privatize” Bashneft – it had been seized by the state – by selling 50.8% to Rosneft, a state-owned company (technically not, per a ludicrous legal loophole). Lukoil had contracts with Bashneft going back years, aided by Alekperov’s personal familiarity with the company’s oilfields and Soviet-era holdovers still working in the oil sector. He expressed interest in acquiring a controlling stake beforehand.

Igor Sechin didn’t like that.

Billionaire Vladimir Yevtushenkov and his group Sistema owned Bashneft before it was expropriated by the Kremlin. He was placed under house arrest in 2014 for money laundering charges connected to his acquisition of Bashneft. There are rumors that it was Sechin who had the charges trumped up, fitting given he was able to have sitting economy minister Alexei Ulyukayev sentenced to hard labor for merely discussing the possibility of privatizing a majority of Rosneft’s shares just a few years after. Bashneft was an attractive asset.

When Rosneft was privatizing 19.5% of its shares to raise money for the budget in late 2016, Alekperov and Lukoil were reportedly approached by Putin himself to take part. Alekperov refused. You don’t spit into the wind and you don’t mess around with Igor Sechin.

Tehran DMC

Lukoil has had a presence in Iraq’s upstream going back to a late 2009 deal to develop the second phase of the supergiant West Qurna field with interests in expanding investments. More importantly, the company led the way for Russian firms in negotiations with Iran as it reopened its office in Tehran in April of 2015. Now Sechin has set his sights on the Middle East.

In search of oil flows for Europe as well as a bigger policy role, Sechin signed deals with Iraqi Kurdistan to finance $2 billion of oil deliveries and take a controlling stake in the region’s primary export outlet – a pipeline running to Turkey’s oil hub at Ceyhan. Sechin pushed the maneuver forward right after Kurdistan’s referendum and Baghdad has yet to recognize Rosneft’s contracts. Rosneft is now a key mediating party for talks between Erbil and Baghdad.

Similar drivers pushed Rosneft to close supply deals with Libya’s National Oil Company and signed deals laying the groundwork for future investments should the security situation improve. These weren’t enough. Iran was next on Sechin’s radar.

Lukoil has dominated any talk of investments into Iran. Alekperov flew to Tehran just two days after the country’s new petroleum contract was endorsed in September of 2016. Public reports focused on Lukoil until last summer when Rosneft began appearing in talks. Sechin has sought to dominate Russia’s relationship with China and extend that influence across the entirety of its Asia-Pacific energy portfolio. Iran is crucial to fully realize that personal ambition.

Sour Crude, Crudely Sour

The corporate relationship between Rosneft and Lukoil, never much good, recently deteriorated further. Rosneft closed a joint venture with Lukoil it inherited from its acquisition of Bashneft at the beginning of March. The venture had been a profitable and effective division of risk and expenditure between the two firms to Rosneft’s loss before the acquisition. Rumors are floating around that Sechin wants to reacquire all the assets held by the Oil Ministry as of 1992. That would mean swallowing up Lukoil.

Most recently, Rosneft has gone after agreements Lukoil has reached to discount exports of oil via facilities at Varandey – an export terminal it owns on the Pechora sea coast. Rosneft’s also reportedly gone as far as to push pipeline monopoly Transneft to build redundant pipelines that would allow it to avoid using anything owned by Lukoil from the relevant oilfields it acquired from Bashneft. The latest moves to end joint ventures with Lukoil seem to presage a shift behind the scenes.

In the past, Russia’s Federal Anti-monopoly Service (FAS) and Putin have backed Lukoil’s participation in privatization deals. But Sechin has won each time. Now he’s angled into the political situation and negotiations in two of Lukoil’s primary international production markets – Iraq and Iran – and faces a Putin term in which it appears he could unseat anyone beneath Putin he chooses, even a prime minister. Why stick around?

Alekperov’s statement was not conclusive. He didn’t provide a timetable. But he did clarify that his children and close relatives would not replace him in a managerial capacity. To allow them to do so would place them at risk. Whoever sits in his chair has to plot a course to survive the increasingly visible pressure Igor Sechin is placing on Russia’s biggest privately-owned oil firm. Once Alekperov steps down, it’s quite likely Sechin will pounce since a successor will invariably be weaker politically.

Even if Lukoil is spared, experienced technocrats and old hands with decades of industry experience are of decreasing relevance to policymaking at the corporate level. No matter public or private, everyone will have to sway to the guff and ambitions of those most directly tasked with executing Putin’s vision, namely Sechin and his associates. That spells trouble for sound corporate strategy sector-wide as the Kremlin has no vision for reform slouching into Putin’s next term.

The comments about not wanting to create a private company are telling. The state comes first these days, no matter what. Alekperov is charting a way out before it’s too late.

This story first appeared in FPRI Bear Markets Brief here