The future of national oil companies in Russia and how they may improve their global competitiveness.

• Author: Olsen, Mike

1. INTRODUCTION II. RUSSIA A. Rosneft B. Gazprom III. LESSONS FROM LUKOIL AND STATOIL A. LUKOIL B. Statoil IV. FUTURE A. Share of Government Involvement B. Global Expansion V. CONCLUSION I. INTRODUCTION

   In 2009, fifteen of the twenty largest oil companies were majority owned by nation states. (1) National Oil Companies (NOCs) have vastly increased in importance and size over the last several decades. In the 1970s, NOCs controlled less than ten percent of the world's oil and gas reserves; that number has increased to more than ninety percent in 2012. (2) This huge swing in percentage of control over the world's oil and gas reserves toward greater NOC control and less control by the major International Oil Companies (IOCs) (3) has significant implications for the international energy market. Some have distinguished between NOCs and hybrid NOCs based on ownership percentage, but this Article will only distinguish between IOCs (majority privately owned and controlled) and NOCs (majority government owned or controlled).

   IOCs seek to maximize shareholder value, (4) achieve production efficiency, (5) and enhance profitability, (6) which benefits consumers by preventing shortages and ensuring more predictable prices. (7) NOCs often have conflicting goals because of the added government control and influence. The objectives of NOCs have been known to include politically motivated wealth re-distribution, wealth creation for the nation, job creation, general economic development, economic and energy security, foreign and strategic policy and alliance building, participation in national level politics, and vertical integration. (8) These noncommercial goals often conflict with a NOC's commercial goals such as the ability to maximize the value of its reserves, replace reserves, expand its production, and perform in a technically efficient manner. (9)

   Not all NOCs are equal; some have been very successful in combining commercial goals and noncommercial state interests to create economic value and a globally competitive company. The most successful NOCs bring global standards home in regards to managerial and operational standards, (10) domestic suppliers, (11) and industries related to oil and gas. (12) Norway's Statoil is an exemplar of this model. In response to declining domestic reserves, Statoil expanded internationally--today nearly twenty-five percent of Statoil's total production comes from outside of Norway (13)--while also building research institutions in Norway and fostering a profitable domestic oil and gas industry. (14) Russia and its NOCs have not been known for balancing state responsibilities with commercial interests in past years, but since both Gazprom and Rosneft went public in 2006--allowing private ownership of shares (15)--the balance has become more equitable. (16) Russia is known for exerting control over most aspects of its NOCs, but as both Rosneft and Gazprom have grown they have become more commercially oriented and less politically controlled. (17)

   The Russian oil and gas sector and its history since the collapse of the Soviet Union will be explained in Part I, which will focus on government influence over the oil and gas sectors and the history of both Rosneft and Gazprom. Part II will cover the experiences of LUKOIL and Statoil and how their respective histories provide lessons for Russian NOCs as they continue to evolve. Finally, this Article will explore the lessons to be learned from Statoil and LUKOIL to the experiences of Rosneft and Gazprom, outline state ownership reforms and methods of international expansion that have been implemented, are in the process of implementation, and should be implemented in the near future by Gazprom and Rosneft.

2. RUSSIA

   "The role of the country in the global energy markets largely determines its geopolitical influence." (18) "The goal of Russia's energy policy is to ensure ... strengthening of its global economic positions." (19)

   Before the 1990s and the collapse of its political machinery, the Soviet Union had built a large energy industry and exported its success to other socialist countries, including but not limited to Algeria, Cuba, Iraq, Iran, Libya, Syria, and Vietnam. (20) During this period, oil exports were a vital source of income and a defining attribute of the foreign policy of the Soviet Union. (21) It built the world's longest oil pipeline between 1960 and 1964 (Druzhba pipeline), bringing oil to East Germany, Poland, Czechoslovakia and Hungary. (22) A second branch, doubling the quantity of oil exports, was built between 1969 and 1974. (23) Western Europe wanted access to Soviet gas reserves but was concerned they would become dependent and thereby less secure with Soviet control of the gas supply. (24) This led to the failure of negotiations between Eni--an Italian oil and gas company--and the Soviet Union in 1966. (25) The West eventually did gain access to those reserves in 1973 when Soviet gas reached West Germany, France, and Finland due to a "gas for pipes" deal struck in 1970 between the Soviet Union and West Germany. (26)

   After the collapse of the Soviet Union there was a mad dash to privatize the Russian oil and gas sector. With the demise of the Soviet system in Russia, many political elites traded their party credentials for top-paying positions at rapidly privatizing former state-owned enterprises. (27) In 1995, in order to finance the government and the 1996 Presidential campaign, the Russian government implemented a "loans for shares" program in which banks made "loans" to the government in exchange for shares in state oil companies. (28) The loans were never repaid and these became bargain purchases of many of the largest state assets. (29) The privatization process began to reverse in 2000 when Vladimir Putin was elected President, but by then, many of Russia's energy assets were held privately. (30)

   President Vladimir Putin has historically seen energy production as a path to "restore Russia's lost greatness after the collapse of the Soviet Union," (31) characterizing the guiding principle for the oil and gas industry when he said, '"[t]he basic strategic tasks for the natural resources sector involve achieving the transition to a rational combination of administrative and economic methods of government regulation in the sphere of resource exploitation."' (32)

   Below is a short history of the two major Russian NOCs (Rosneft and Gazprom), including their challenges and successes over the last two decades.

   1. Rosneft

      "Rosneft's true ambition is to become not the world's largest publicly traded oil producer, but rather 'the most efficient' ..." (33)

      Rosneft faced huge obstacles as a state run company in the fervor of privatization. When Presidential Decree Number 1403 kicked off privatization of the Russian oil industry, Rosneft was to act as a state oil company and manage 259 of 301 oil enterprises operating in Russia. (34) While this gave Rosneft over sixty percent of domestic oil production, it soon began to lose its most attractive assets. (35) In August 1995, it was forced to sell Nizhnevartovksneftegas to Tyumen Oil Company and was deprived of four other assets in favor of Sibneft, a company believed by some observers to be a proxy for funding Boris Yeltsin's 1996 Presidential campaign. (36) Not even local Russian government trusted the state-run company; Rosneft lost management of a sizeable Moscow refinery and Mosneftepoduct marketing to the mayor of Moscow in February 1997. (37)

      Further exacerbating Rosneft's troubles with the state, the government prevented Rosneft from expanding internationally into a German refinery. (38) In 2000, Rosneft, Surgutneftegas, and Megionneftegas (all Russian companies) were to be shareholders and suppliers of crude to the Leuna-2000 refinery built in Germany by France's Elf Aquitaine, but the Russian government delayed preparation of documents for so long the deal fell apart. (39) As of 2010, the Leuna-2000 refinery continues operations without Russian crude. (40)

      While Rosneft did benefit from the ability to handle sales of the state's shares of Production Sharing Agreements, it lagged behind its privatized counterparts by failing to foster the commercial principles that flourished in Russia in the 1990s. (41) Rosneft was seen as one of the least efficient oil companies in the sector. (42)

      Rosneft struggled to resist privatization during most of the 1990s. The CEO, Alexander Putilov, was fired and made Chairman of the Board, in which position he subsequently fought with the new CEO over privatization. (43) Prior to dismissal of the Chernomyrdin government, the government approved a plan for privatization through sale of seventy-five percent plus one share of Rosneft stock for $2.1 billion plus $400 million of investment conditions. (44) However, the auction was shunned by foreign investors and labeled "ridiculously inflated" by the CEO of Yukos. (45) An outside group (Alliance Group) was brought in to turn Rosneft around to make it more attractive for sale; (46) but when the Board of Directors delayed in signing a contract with Alliance Group for a couple weeks in August 1998, the August 17 financial crisis struck and the government was dismissed. (47) On August 27, the Alliance Group announced it could not manage Rosneft and the turn-around was abandoned. (48)

      In October 1998, Sergei Bogdanchikov, the former director of Sakhalinmorneftegas, was appointed the head of Rosneft. (49) In 2000, Vladimir Putin became president of Russia and Rosneft was poised to forward his goal of state control over the Russian energy sector. (50) Under Bogdanchikov and with the backing of the new Russian government under President Putin, Rosneft consolidated its assets. (51) Rosneft acquired more than seventy-five percent of the shares in its remaining assets, but used tiered pricing structures, completely devaluing the remaining shares and paying a portion of the previous market value...