Russian Involvement in Eastern Europe's Petroleum Industry: The Case of Bulgaria (Russian Foreign Energy Policy)

RUSSIAN INVOLVEMENT IN EASTERN EUROPE’S PETROLEUM INDUSTRY The case of Bulgaria

Adnan Vatansever Series editor: Dr Kevin Rosner

Publisher’s note Every possible effort has been made to ensure that the information contained in this publication is accurate at the time of going to press and neither the publishers nor any of the authors, editors, contributors or sponsors can accept responsibility for any errors or omissions, however caused. No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result of the material in this publication can be accepted by the editors, authors, the publisher or any of the contributors or sponsors. Users and readers of this publication may copy or download portions of the material herein for personal use, and may include portions of this material in internal reports and/or reports to customers, and on an occasional and infrequent basis individual articles from the material, provided that such articles (or portions of articles) are attributed to this publication by name, the individual contributor of the portion used and GMB Publishing Ltd. Users and readers of this publication shall not reproduce, distribute, display, sell, publish, broadcast, repurpose, or circulate the material to any third party, or create new collective works for resale or for redistribution to servers or lists, or reuse any copyrighted component of this work in other works, without the prior written permission of GMB Publishing Ltd. GMB Publishing Ltd. 120 Pentonville Road London N1 9JN United Kingdom www.globalmarketbriefings.com This edition first published 2006 by GMB Publishing Ltd. © Adnan Vatansever Hardcopy ISBN 1-905050-40-2

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British Library Cataloguing in Publication Data A CIP record for this book is available from the British Library

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Contents Introduction

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Executive summary

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1. Russian oil companies and international downstream petroleum

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Why Eastern Europe and Western FSU?
Drivers for expanding abroad
The Russian state and downstream expansion abroad

2. LUKoil’s leading role in foreign downstream acquisitions

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3. LUKoil’s acquisition of the Neftochim refinery

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Neftochim prior to LUKoil’s acquisition
The privatization of Neftochim
Neftochim under LUKoil’s ownership

4. Russian involvement in Bulgaria’s fuel market privatization

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Petrol AD’s privatization
Petrol AD after privatization
Bulgaria’s fuel sector after Petrol AD’s privatization

5. Conclusions

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Notes and references

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About the series: Russian foreign energy policy reports

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Introduction ussia’s hydrocarbon sector has contributed largely to the recent boom in the country’s economic development. This sector, however, has implications far beyond Russia’s borders. Suddenly, Russian energy companies have joined the trend of globalization by rushing to acquire assets in foreign countries. Indeed, based on data on proven reserves, many Russian oil companies are on a par with the world’s largest oil majors and from a reserve standpoint exceed many of them. Similarly Gazprom, Russia’s major gas company, is the indisputable leader in world gas reserves, which guarantees it a leading role in the future. As Russia’s hydrocarbon sector continues to prosper, Russian companies will maintain the potential to expand their role in the world. This report traces the origins of the drive for foreign acquisitions by Russian oil majors. It highlights the conditions in which Russian companies decided to penetrate foreign downstream and midstream markets. It evaluates the various

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domestic and external factors that prompted Russian majors to seek for assets abroad. A heavy emphasis in this analysis is on LUKoil, the Russian oil major that has managed to emerge not only as the largest oil company in the country, but also as the categorical Russian leader in successful acquisitions abroad. As an illustration of the foreign acquisition drive of Russian oil majors, the report provides a detailed case study of Bulgaria, a country where Russian companies have had considerable success. For this purpose, LUKoil’s acquisition of Bulgaria’s Neftochim refinery is analyzed. Neftochim is the largest asset that has been acquired by a foreign entity in Bulgaria, as well as the largest refinery taken over by LUKoil abroad. In addition, the report provides a detailed analysis of Russian involvement in Bulgaria’s fuel marketing sector with a particular focus on the privatization of Bulgaria’s main retail outlet owner, Petrol AD.

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Executive summary ussian oil companies, being newcomers to the international oil market, have gained increasing attention as a result of their acquisitions of major downstream assets in foreign countries. Since the late 1990s, Russian majors headed by the country’s largest oil company LUKoil have continued to stun observes with their aggressive strategies for expansion abroad. This report addresses three major questions in this drive for foreign acquisitions by Russian companies:

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What drove these companies to pursue the acquisition of downstream assets abroad?
Why have Russian oil majors chosen Eastern Europe and several countries in Western FSU (former Soviet Union) as the primary arena of their foreign expansion?
What has been the attitude of Russian governments in promoting this drive for foreign acquisitions? On the first question, there is hardly a uniform explanation as most Russian companies have followed different growth strategies and have shown diverging interests in regard to assets abroad. However, several factors could be considered as the principal factors in their acquisition drive so far:
After over half a decade of consolidation in Russia’s oil industry, opportunities for growth through acquisitions inside Russia started to dwindle by the end of the 1990s. As a result, Russian oil majors started turning their attention abroad.
In the context of an infrastructure significantly limiting the opportuni-

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ties for crude exports, the collapse of domestic crude and fuel prices has been common. Thus Russian oil majors have been tempted to pursue vertical integration through foreign acquisition of downstream assets as a means of risk minimization.
Russian majors have hoped to alleviate their tax burden through foreign acquisitions.
A common belief among the leadership of several Russian oil majors has been that they can and should become transnational companies on a par with international majors.
Foreign downstream assets have been commonly perceived as a means for securing a market share for the growing crude production of Russian oil companies. There are several explanations of why Russian oil majors’ foreign acquisitions have occurred mainly in Eastern Europe and part of Western FSU:
The business environment in these regions, marked by weak law enforcement and a lack of transparency, provided a comparative advantage for Russian oil majors against their Western rivals.
Russian companies were often able to provide practical solutions for the downstream petroleum sector in these regions: they were able to secure crude supplies and they were willing to plough in significant investments.
The perceptions of Russian oil majors on the prospects for downstream market development in these regions have generally been highly optimistic. This has been mostly

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fueled by the process of European integration in which most of the countries in the two regions are involved. On the attitude of Russian governments towards foreign acquisitions, it is possible to conclude that:
Russian policy-makers have perceived these acquisitions as a means of gaining leverage in Russia’s relations with countries in FSU, as well as Eastern Europe.
However, their support for Russian companies has remained mainly verbal and poorly coordinated.

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Within this context, this report examines Bulgaria where the above statements are illustrated through two detailed case studies. One of them involves the acquisition of Bulgaria’s Neftochim refinery, the country’s largest asset acquired by a foreign company and the largest refinery taken over by Russia’s LUKoil. The second study focuses on the involvement of companies with strong Russian presence in the privatization of Bulgaria’s largest retail outlet owner, Petrol AD.

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1. Russian oil companies and international downstream petroleum novelty for the world oil industry stunned observers towards the close of 2000, when Russian oil company LUKoil made its debut in the US downstream market. The company announced its acquisition of Getty Petroleum’s 1,260 filling stations located along the US East Coast. For most of the 20th century the Soviet Union, and subsequently Russia, was one of the world’s leading producers of crude oil, but never had it achieved any presence in the downstream petroleum markets of the Western world. Far less noticed than the Getty acquisition was the fact that Russia’s largest oil producer, LUKoil, had already been in a drive for downstream expansion abroad for more than a couple years. It had acquired three refineries in Eastern Europe in Romania, Ukraine and Bulgaria. Moreover LUKoil was not the only company involved in this drive for expansion. Other Russian oil majors had followed suit partitioning most of Ukraine’s refining industry. TNK had acquired control over the Lisichansk refinery, while Alliance Group and Rosneft obtained major stakes in the Kherson refinery. This trend continued in the following years. Yukos, parallel to is ascendance in Russia’s oil sector, joined actively in the struggle for acquisitions abroad. It obtained a controlling stake in Lithuania’s Mazeikiu Nafta, the largest refinery in the Baltics with significant pipeline assets and an export terminal (Butinge). It also acquired a major stake in Transpetrol, Slovakia’s crude pipeline network owner.

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The Gazprom-associated Sibur, on the other hand, managed to get major stakes in Hungary’s two leading companies in the petrochemical industry, BorsodChem and TVK. Finally, Russian majors appeared at various stages in competition for downstream asset acquisitions in Greece, Turkey, Poland, the Czech Republic and Croatia. While their involvement in these countries did not result in the takeover of new downstream assets, it was highly indicative of the growing appetite of Russian majors for pursuing downstream expansion abroad. Within these parameters, three major questions should be addressed. First, why have Eastern Europe and Western FSU (former Soviet Union) countries appeared as the primary focus of Russian downstream acquisitions? Second, what drives LUKoil (and other Russian oil companies) to pursue acquisition of assets in these regions? Finally, what is the stance of the Russian government in terms of promoting such acquisitions abroad?

Why Eastern Europe and Western FSU? Assets in Eastern Europe and Western FSU countries have appeared as the primary downstream targets for Russian oil companies. With very few exceptions, all Russian acquisitions have been focused in these two regions. Attention to downstream assets in the industrialized West remained largely limited, partly owing to perceptions

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of relatively low profit margins due to the high level of competition prevalent in their markets.1 Other parts of the FSU have largely been left untouched as target destinations for acquisitions by Russian oil companies. This is mainly the result of the presence of several oil producers in these regions that have their own downstream complex integrated with upstream partners. In short, these indigenous companies are reluctant to cede control over their downstream assets. Meanwhile, countries with no oil deposits or those lacking well established downstream assets or possessing small fuel markets have failed to attract the attention of Russia’s oil majors. The exceptional interest of Russian oil companies in Eastern Europe and Western FSU derives from several factors. First, most countries in the region only initiated the privatization of their oil industry late in the 1990s or even in the 2000s. Privatization in Russia’s oil sector occurred much earlier, providing ample time for restructuring. This led to the emergence of several powerful vertically integrated companies that began taking over available new assets in Eastern Europe and Western FSU at the end of the 1990s. Had the oil industry of both regions been concurrently privatized in the early 1990s, the Russian majors would have had a harder time competing against local or other international oil companies. Second, at least in the past few years, the Russians appeared to have had a comparative advantage over Western oil majors in most of the countries of the region. What seemed to be challenges for Western oil majors, often turned into an opportunity for Russian oil companies: a business environment characterized by weak law enforcement and lack of transparency, daunting for Western oil majors, is highly familiar to Russians. Reviving ties with former colleagues and associates was often an easier task than building new relationships. Russian companies were familiar with the region’s assets (most of them based on Soviet technology), they appreciated the challenges of managing the oil industry

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across these regions and in most cases they had already established close ties with ministerial bureaucracies. This understanding was strengthened by Russia’s ongoing role as a primary crude supplier for regional downstream endusers, which is particularly true for the FSU republics, where the oil industry had, in fact, been a part of a single industry managed from Moscow. Third, amidst widespread antagonism against Russians’ acquiring assets in Eastern Europe and Western FSU, Russian oil companies were often perceived as providing practical solutions to a predicament prevalent in many countries of the region. For years, many of the region’s refineries had been drawn into a vicious cycle. Often, due to government control over fuel prices, they accumulated sizeable debts. This led to periodic interruptions in their access to crude, and moreover, obstructed any efforts aimed at the refurbishment or modernization of these refineries. Even with liberalized fuel prices, the vicious cycle would persist, as the inability to pay for crude or for modernization programmes would keep most refineries working at low capacity and therefore close to insolvency. Under these circumstances, Western oil majors showed little interest in acquiring refineries. Russian companies were better placed to break this vicious circle. Accordingly a refinery taken over by a Russian oil major would have little problem with access to crude. Meanwhile, in some cases, the Russians have been willing to accept terms that have required them to assume some of the refineries’ debt. In others, the Russians have demonstrated their willingness to plough in significant amounts of investment capital for modernization purposes, which could potentially transform outmoded heavy industries into entities that are both nationally as well as globally competitive. Not coincidentally Russian oil majors have had their greatest success in acquiring downstream assets in countries that

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had been plagued by severe economic problems, such as Romania, Bulgaria, Ukraine, and where refineries had been often starved for crude due to financial problems or, at least partially, as a result of Russian pressures (as was the case with Mazeikiu Nafta in Lithuania). The relatively greater financial strength of the refining industry in countries such as Poland, the Czech Republic, Hungary and Greece, has been the major reason behind repeated failures of Russian attempts to make downstream acquisitions in these particular countries. Finally, the management of many Russian oil majors entertained optimistic perceptions about the prospects for overall economic, as well as downstream energy market developments in Eastern Europe and Western FSU.2 By late 1990s most of the countries in the region had already begun negotiations for accession to the EU, while in the meantime, many of them had joined the Central European Free Trade Agreement (CEFTA).3 With the process of European integration at full speed, Russian oil majors hoped to establish a presence in these countries that could potentially open the door towards further penetration of the EU market.4 Meanwhile the considerably lower level of vehicle ownership in this region compared to vehicle ownership rates in the more mature economies of EU members raised the hopes of Russian oil companies for good growth prospects in fuel consumption.5

Drivers for expanding abroad LUKoil’s president, Vagit Alekperov, believes that what accounts for the spreading penetration of Russian oil majors abroad is the confluence of high world oil prices, Russia’s fast pace of oil production growth and an increase in the efficiencies of Russian companies achieved through the high level of competition inherent in

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the Russian market for the last several years. Alekperov believes that these factors have rendered Russian oil majors flush with money and eager to acquire assets beyond their border.6 While these observations by one of Russia’s senior oil executives may be correct, they hardly provide a uniform explanation as to what has driven Russian oil companies’ attention to acquiring midstream and downstream assets abroad. Not all companies have appeared equally interested in acquiring foreign assets. While LUKoil, Yukos, TNK, Tatneft and to some extent Rosneft have demonstrated vivid interest in foreign acquisitions, others such as Sibneft, Surgutneftegaz and Bashneft have preferred to focus mainly on their business within Russia. Similarly, since 1998, the year of the first major Russian acquisition in foreign downstream (Petrotel, Romania), Russian oil companies have faced different challenges and opportunities. Thus there is a notable contrast between the 1998-99 period of low world oil prices and a stagnating Russian oil industry and the subsequent period marked by a sharp rise in oil prices and burgeoning oil production. Amidst calls for a growing tax burden on the oil sector, Russian majors have perceived the opportunity to lower their taxes through acquisitions abroad.

Yet, on a broader range of issues, Russian oil majors have faced similar concerns and incentives which may explain the burst in their interest in acquiring foreign downstream and mid-stream assets. Part of this interest can be explained by the ongoing process of consolidation in Russia’s oil industry. For most of the 1990s, the major strategy for Russian companies was growth through the acquisition of assets within the Russian Federation. But the number of these opportunities dwindled by the end of 1990s. By then, the Russian oil industry had largely consolidated into

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about a dozen Russian vertically integrated companies with few additional national remaining assets. Accordingly refineries, retail stations, petrochemical plants, ports and pipelines in neighboring countries emerged as natural targets for Russian companies striving for growth. This drive for vertical integration through foreign acquisition was in line with the self-perception of Russian majors such as LUKoil and Yukos. A common belief within their management cultures is that they can and should become transnational companies on a par with the international majors.7 In fact, based on oil reserves recorded in the portfolio of these two companies alone, they are already ahead of many of their international competitors. Thus towards the end of 1990s, when their major deficiency appeared to be the lack of foreign assets, this began to be addressed through downstream (as well as some upstream) acquisitions beyond Russian borders. The ambition for vertical integration within and outside Russia was coupled with concerns about restrictions on export of crude and refined products. Part of the problem was caused by government policies aimed at maintaining some level of control over domestic fuel prices. But an equally important cause was a lack of sufficient infrastructure for exporting crude oil and fuels: an issue that continues to create a major challenge for Russian majors today. This has resulted in the frequent collapse of domestic crude and fuel prices in Russia, which in turn erodes oil majors’ profit margins. Thus by acquiring assets abroad, Russian companies have hoped to benefit in a number of ways. Mainly they perceive vertical integration through foreign acquisition as insurance against repeated price collapse within Russia. Countries in Eastern Europe and Western FSU have historically had domestic fuel prices more in line with international markets, partly due to their negligible domestic oil reserves and in general due to a greater openness to trade than their Russian counterparts. Executives of Russian oil majors have repeatedly under-

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scored these points, while emphasizing the presence of higher profit margins in Eastern Europe and Western FSU’s downstream markets.8 Apart from this, many Russian oil companies have hoped to get extra allocations for crude oil exports thanks to owning refineries abroad. These downstream assets provide a convenient ‘excuse’ for demanding extra export quotas from government officials. Finally, acquiring mid-stream assets, such as export terminals or pipelines, directly addresses Russian companies’ concerns about exporting their crude. Thus, for instance, Yukos acquired Transpetrol and got involved in negotiations aimed at reversing the Adria pipeline, which would secure export access through the Adriatic port of Omisalj. Similarly the same company acquired control over a major Baltic export port, Butinge, through its takeover of Lithuania’s Mazeikiu Nafta. Tax concerns of Russian oil majors have provided an additional cause for their expansion into Eastern Europe and the Western FSU. Amidst calls for a growing tax burden on the oil sector, Russian majors have perceived the opportunity to lower their taxes through acquisitions abroad. Thus fuels refined in these countries face no (or considerably lower) duties when exported to neighboring markets. Moreover, geographically, they are positioned closer to European markets, which also translates into lower transportation costs for the Russian majors. Likewise Russian companies can hope to benefit from transfer pricing through transactions with their downstream subsidiaries. Finally, downstream assets abroad can potentially secure individual Russian majors a market share for their growing crude production. Faced with the prospect of Caspian or North Sea crude replacing Russian blend, Russian oil companies have maintained their ambitions to sell their crude oil in Eastern Europe and Western FSU. Moreover,

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for the past decade, they have competed with each other for selling their crude to these regions’ markets. Therefore owning a refinery is perceived as a valuable means to maintain position in providing crude in these two regions. Furthermore for years they have been forced to pay commissions to middlemen who purchase crude from them and supply it to the regions’ refineries. Owning their own refineries is seen as a means to put an end to selling their crude at a discount.

The Russian state and downstream expansion abroad The picture of foreign downstream acquisitions by Russian oil companies would be incomplete without taking into account the attitude of the Russian authorities. A number of means, such as taxation policy and the allocation of export quotas controlled by the Russian government, can potentially foster or obstruct Russian majors’ ventures abroad. In this respect, this section briefly focuses on several questions:
What are the common interests between the Russian authorities and oil companies on their expansion abroad?
What state-controlled incentives have driven or obstructed Russian oil companies’ foreign acquisitions?
What is the evidence for government officials promoting foreign acquisitions? Additionally, Russian officials have expressed support for policies that will prevent, or at least delay, the diversification of Eastern Europe and Western FSU’s sources of crude oil and gas. In all these respects, the Russian government has unambiguously common interests with Russian oil companies.

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The expansion of Russian oil companies in Eastern Europe and Western FSU has resonated widely among Russian policymakers. Left with limited leverage over these two regions, especially after the turbulent 1989-91 period, officials in Moscow had to confront an equally disturbing trend by the late 1990s: nearly all the countries in the region, except Ukraine and Moldova, entered the trend of integration with the EU and/or NATO. As a result Russian policy-makers have hoped to gain some leverage through the most valuable economic asset they have – oil and gas. Thus acquisitions have been widely perceived as securing a foothold in regions where integration into western institutions threatens further alienation from Russia. Additionally, Russian officials have expressed support for policies that will prevent, or at least delay, the diversification of Eastern Europe and Western FSU’s sources of crude oil and gas. In all these respects, the Russian government has unambiguously common interests with Russian oil companies. There is significant evidence about the support provided by Russian authorities to their oil majors venturing abroad. Thus, for instance, Alekperov has proudly noted the support LUKoil have been enjoying from the Russian Ministry of Foreign Affairs.9 Putin has also praised LUKoil for its foreign acquisitions and, until 2003, repeatedly called on Yukos to expand its attention on downstream assets abroad.10 Similarly Viktor Chernomyrdin, Russia’s former prime minister, is notorious for providing his assistance to Russian oil companies in their business in Ukraine during his appointment as ambassador.11 His connections with the former president, Leonid Kuchma, were a valuable asset enjoyed by Russian oil companies operating in Ukraine. Apart from this, Russian officials have repeatedly called for greater openness to Russian capital and lobbied for its penetration during their visits in Eastern Europe and Western FSU.

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Despite the support of Russian officials, however, there is no evidence that any of the Russian downstream and mid-stream acquisitions in Eastern Europe and Western FSU, have been planned by policy-makers in Moscow. In fact the peak period of Russian acquisitions (1998-2000) was marked by a relatively weak state, which hardly had any of the control over oil companies that it started to enjoy by 2003, when the ‘Yukos affair’ began. Moreover, in this period, it was quite possible for oil companies to have an agenda different than the ones of the Russian authorities, and the Ministry of Foreign Affairs in particular. The most extreme example was related to LUKoil’s upstream activities in Azerbaijan, which led to extensive quarrels between the company and the ministry in the 1990s. Similarly, the often pronounced verbal support of Russian officials for acquisitions abroad was not matched with attempts to create the necessary economic incentives for oil companies willing to expand beyond Russia’s borders. Generally Russian authorities tried to maintain an equal export/production ratio for Russian oil majors’ exports to non-CIS (Commonwealth of Independent States) countries through Transneft’s trunk line (with the partial exception of Rosneft, which was consistently awarded higher export allocations). Also, with regards to the Ukrainian market, which by 2001 had mostly gone under Russian control,12 Russian oil majors were allocated equal export quotas in 2002. This was regardless of their ownership of a refinery, which they had hoped would enhance their ability to secure extra export allocations. Nevertheless President Putin has been supportive of Russian acquisitions abroad

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and has placed the energy sector high both in his domestic and foreign policies. In the economic sphere, he has expressed his conviction that Russia should avoid transforming itself merely into the rawmaterial provider for the industrialized world. For this purpose he has supported reformist liberals, whose policies call for diversification of the Russian economy. But he has not abstained from defying their criticism of Russian acquisitions abroad. Liberals have often accused companies such as LUKoil and Yukos of contributing to the nation’s predicament of capital flight. For Putin, however, foreign acquisitions are just another expression of following the path of industrialized countries, such as the US, the UK and France, which have built strong transnational oil majors that Russia should emulate. Putin’s rising power, however, has not been matched with a wave of new downstream and mid-stream acquisitions in Eastern Europe and Western FSU. The attacks on Yukos, in fact, have limited the ability and will of Russian oil companies to expand abroad. Yukos has been sidelined and is unable, at least at present, to continue its drive for foreign takeovers. This indicates that possession of assets abroad does not provide a safeguard against policies of the Russian government which may be carried out against Russian oil companies. Faced with the Yukos debacle, most Russian majors have remained cautious about new ventures. Similarly the rising tax burden on the oil sector, favoured by Putin, has contributed to a slowdown in foreign acquisitions.

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2. LUKoil’s leading role in foreign downstream acquisitions fter more than half a decade of Russian penetration in foreign downstream, LUKoil has emerged as the Russian oil major with the biggest acquisitions abroad. Furthermore it was the first Russian company to develop a strategy of acquiring foreign downstream assets outlining a path for Russia’s other majors to follow. LUKoil’s first downstream acquisitions abroad, namely those in 1998-99, coincided with a stagnant period for the oil sector in Russia and with a period of relatively low profitability for the company. Thus in the period 1996-99, total crude production in Russia decreased by 0.2 per cent,13 while LUKoil’s profits stood at $312m and only $12m in 1997 and 1998 respectively.14 So the rise in world prices and the boom in Russia’s oil sector came after LUKoil’s early acquisitions, providing a boost to the company’s growing appetite for foreign assets. In an interview with the Russian daily Izvestia, the head of LUKoil, Vagit Alekperov, referred to the period 1996-97 as the origin of his company’s strategy to expand into foreign downstream markets through acquisitions.15 By then, LUKoil had already become a major crude provider to countries such as Bulgaria, Romania and Ukraine, and was well acquainted with the petroleum business in these countries. Its subsequent decision to take over refineries in each of these countries was part of a strategy focused on growth through acquisitions instead of upstream investment. The other Russian oil majors also followed a similar strategy,

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but had not turned their eyes on assets beyond Russian borders yet. Yukos, which would soon become a primary competitor for LUKoil, both inside and outside Russia, was still in a relatively early process of consolidation, lagging considerably behind LUKoil, the leader in the Russian oil business. LUKoil’s first bid for a refinery in Eastern Europe occurred in Romania. In 1997, the Romanian government initiated a privatization program for its oil refining industry. LUKoil showed interest in the Petrotel refinery, one of Romania’s larger refineries with a nameplate processing capacity reported to be nearly 5m tonnes a year prior to its privatization.16 The Russian major acquired a 51 per cent stake in the refinery at the beginning of 1998 paying $52m, promising to invest $189m for modernizing the refinery and $11m for environmental purposes. It also agreed to assume $53m of the refinery’s debt. This subsequently helped to raise LUKoil’s equity in the refinery above 93 per cent. Another target for the Russian major emerged in Ukraine, following its revitalized plan to privatize its petroleum sector in 1998-99. Russian companies were interested in the relatively cheap Ukrainian refining assets that were on the verge of insolvency due to the sudden collapse of petroleum demand in Ukraine and due to their frequent problems with access to crude due to rising debt.17 LUKoil set its eye on the Odessa refinery. It was a relatively small (Ukraine’s fourth largest) and less sophisticated refinery with

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a nameplate capacity of 5.5m tonnes a year. Only a fraction of this capacity had been utilized prior to its privatization due to severe difficulties experienced in securing payments for crude oil stock. The Russian company paid $6.9m for 51.9 per cent of the refinery’s shares in February 1999. In exchange for the refinery’s low price, LUKoil agreed to pay half of its outstanding debt, invest $1.2m in reconstruction and guarantee crude supplies of at least 2.4m tonnes a year for the following five years.18 Subsequently, LUKoil increased its stake in the refinery above 95 per cent through share purchase. LUKoil’s next acquisition occurred in Bulgaria, where it obtained a controlling stake in the Neftochim refinery. While, this acquisition is evaluated in detail below, it is important to note that the refinery turned out to be LUKoil’s largest foreign acquisition, as well as the last foreign refinery it succeeded in adding to its assets. Its subsequent bids for foreign downstream businesses have either failed or have been outside the refinery business. Among its successful bids, the first one was in one of Ukraine’s largest petrochemical plants, Oriana. In October 2000,

LUKoil acquired a controlling stake in Oriana by committing to pay the company’s outstanding debt of $97m and to invest $240m in the subsequent ten years. Before the close of 2000, LUKoil concluded another takeover deal. This time, the Russian major made inroads in the US downstream market, acquiring control over Getty Petroleum’s 1,260 retail stations located in 13 north-eastern and mid-Atlantic states on the US East Coast. While LUKoil paid only $71m for this purchase, it appeared as the first acquisition of a publicly listed US firm by a Russian corporation.19 A few years later, rebuffing allegations about the low profitability of its ventures in the US, LUKoil decided to step up its presence. It acquired 795 retail stations in New Jersey and Pennsylvania belonging to ConocoPhillips. This time it paid a much higher price, $265m, bringing its total number of retail stations in the US above 2,000.20 Another country that LUKoil was able to penetrate was Serbia-Montenegro. In 2003, it purchased 79.5 per cent of Serbia’s second largest (after Jugopetrol) retail chain owner, Beopetrol.

Table 1. LUKoil’s international downstream acquisitions Country

Asset

Year

Cost at ac quisitio n

Romania

Petrotel (refinery)

1998

Ukraine

Odessa (refinery)

1999

Bulgaria

Neftochim (refinery)

1999

Ukraine

Oriana (petrochemical plant) 2000

USA

Getty Petroleum (retail outlets) Beopetrol (retail outlets)

$52m for 51% stake; $200m committed investment; $53m debt payment $6.9m for 51.9% stake; $1.2m committed for investment $101m for 58% stake; $268mn committed investment; $228m committed debt payment $240m committed investment; $97m committed debt payment $71m

Serbia and Montenegro USA Finland

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2000 2003

ConocoPhillips (retail outlets)2004 Teboil and Suomen Petrooli (retail outlets) 2005

$127m for 79.5% stake; $92.4m committed investment $265.75m $160m

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For the 202 retail stations owned by Beopetrol, it offered $127m and committed to invest $92m in the Serbian company over the following five years.21 The Russian major continued its acquisition drive in 2005. It purchased Teboil and Suomen Petrooli, two affiliated Finnish companies.22These two companies owned 289 retail outlets, and were involved in the production of lubricants and in the wholesaling of fuels. The amount of this transaction was $160m.23 Besides successful acquisitions abroad, LUKoil has demonstrated interest in a few other major downstream assets. In each case, the Russian major either failed outright to acquire the asset or its interest in the opportunity waned over time. While none of these opportunities has resulted in new takeovers, they indicate that LUKoil’s craving for assets in Eastern Europe and Western FSU go far beyond what it was able to acquire as of 2005. LUKoil showed early interest in the Czech Republic. It submitted an offer for a small refinery, Paramo, which had an annual capacity of 0.8m tonnes. This refinery was eventually sold to Unipetrol, the owner of the two other refineries in the country, which was itself in the process of privatization. LUKoil intended to bid for the 62.99 per cent stake of Unipetrol offered by the government, but eventually rescinded its offer on the grounds of the group’s prospective low profitability.24 The Russian major witnessed similar setbacks in Poland and Lithuania. When the Polish government announced the sale of 75 per cent of its second largest refinery, Rafineria Gdanska (RG), LUKoil responded with a strong interest in acquisition. After several failed attempts, however, the government suspended its privatization in mid-2003, reorganizing the refinery under a new structure, the Lotos Group. For this refinery with an annual capacity of 4.5m tonnes, LUKoil offered to pay a record high of $1.7bn.25 In Lithuania, LUKoil attempted to take over the country’s largest company in the petroleum sector, Mazeikiu Nafta. From

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1999 to 2001, the US-based Williams International, which had a major stake in the Lithuanian company, was put under pressure to transfer its shares to LUKoil. Eventually the US company sold its stake to Yukos. LUKoil’s interests in foreign assets extended to other parts of Eastern Europe as well. As early as in 1999, it established a strategic partnership with the Greek major Hellenic Petroleum. Following the initiation of its privatization, LUKoil joined forces with the Greek-owned Switzerland-based Latsis Group, offering €450m for 23.17 per cent of Hellenic Petroleum. Eventually, LUKoil retracted its participation and the Latsis Group continued alone in the privatization deal. In a similar fashion, LUKoil showed interest in the privatization of Croatia’s INA and Romania’s Petrom. Both privatization deals were, in fact, concluded successfully with Hungary’s MOL acquiring a 25 per cent stake in INA and Austria’s OMV purchasing a 51 per cent stake in Petrom. In both cases, LUKoil chose not to compete further with the other leading companies that had expressed interest in these assets. Lukoil’s suspension of involvement in certain acquisition opportunities has often been interpreted as an indication that the Russian major’s craving for foreign assets has already been satisfied. Indeed, on many occasions, company executives have announced their intention to narrow their interest to acquiring assets that prospectively guaranteed returns above a certain threshold. In this regard, in the fall of 2003, Alekperov announced that his company would not be interested in the further privatization of Unipetrol, as well as the sale of 65.76 per cent stake in the Turkish refining company Tupras. He cited the low profitability of both companies, which ‘did not meet LUKoil’s corporate norm of 15 per cent’.26 Meanwhile one of the chief personalities responsible for designing LUKoil’s expansion strategy through foreign downstream acquisitions, first vice-

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president Ralif Safin, resigned towards the end of 2002, in order to start a political career in the Russian Federation Council.27 In another instance at the end of 2003, LUKoil’s management sold its retail stations in the Czech Republic and decided to close its representative office.28 The industry largely regarded this as another setback in LUKoil’s drive for expansion in foreign downstream. None of these instances, however, indicate a reversal or termination of LUKoil’s expansion strategy abroad. First, LUKoil continued its expansion drive throughout 2003-2005. As noted above, it acquired Beopetrol in 2003, cut a deal with ConocoPhillips on the purchase of retail outlets in the US in 2004, and took control over two Finnish companies in early 2005. Furthermore, in April 2005, LUKoil announced that it had started negotiations to buy Yukos’ 53.7 per cent stake in Lithuania’s Mazeikiu Nafta.29 Second, in early 2004, the Russian major revealed a 10-year strategic development programme, where the acquisition of foreign downstream assets appears as a high priority. The company’s deputy head for strategic planning, Sergei Rogov, announced that LUKoil’s crude processing capacity outside Russia should rise to 45 per cent of its overall refining capacity.30 In 2003, the company’s three refineries abroad had processed 7.9m tonnes or 19 per cent of the company’s total refining volumes of 42m tonnes.. As LUKoil plans to expand its crude output up to

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110m tonnes a year by the end of 2014, its policy of balancing its upstream growth with downstream investments implies further growth of refining capacity both in and outside of Russia. Furthermore, the plan also includes reducing the amount of refined products exported from Russia as an indication of a projected rise in exports from refineries located in European countries. In addition, LUKoil aims to increase its retail stations from 3,887 in 2004 up to 6,230 by 2013 by penetrating new markets. The cost of its ten-year downstream strategy is estimated at about $4.3bn.31 Finally, LUKoil has emerged unscathed in the wake of the Yukos debacle as Russia’s premier petroleum company. It has chosen to have amicable relations with Putin by avoiding confrontation with Russia’s principal political figure. With a rising Russian governmental tide favoring state-controlled companies, in 2005 LUKoil concluded a ten-year agreement in the form of a strategic partnership with Gazprom, which in turn may be a valuable asset for LUKoil in its future relations with the state. Meanwhile, as a result of the destabilization of Yukos, TNK’s merger with BP and Rosneft’s potential focus on new upstream fields in Russia, LUKoil will most likely remain in the driver’s seat of Russian penetration in foreign markets through the acquisition of downstream hydrocarbon assets.

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3. LUKoil’s acquisition of the Neftochim refinery he Neftochim refinery is the largest Bulgarian asset acquired by a foreign entity in the post-communist era. Concurrently, as of 2005, it is the largest refinery taken over by LUKoil outside Russian borders. This section analyzes in detail the takeover of the refinery by the Russian major. It focuses upon three stages in Neftochim’s post-communist existence: the state of the refinery prior to its acquisition; the privatization process which resulted in LUKoil’s takeover; and, finally, the refinery under the management of the Russian major.

T

Neftochim prior to LUKoil’s acquisition Neftochim is the largest refinery in the Balkans with a nameplate capacity of 11m tonnes a year. Due to the dilapidated state of the refinery itself, its actual capacity prior to its privatization was estimated at around 8m tonnes.32 Opened in 1963, the refinery was designed with Soviet technology to process crude with medium sulphur content. Throughout the 1990s, the refinery was supplied primarily with Urals blend (about 80 per cent of the total supply), and the rest came mainly from Iran and occasionally from Iraq.33 Rosneft was the largest supplier, especially after 1995 when it came into agreement with Neftochim on the establishment of a joint venture named Rosbulneft.34 Other suppliers of Neftochim included: the Swissbased traders Glencore and Marc Rich;

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Spain’s Arcadia; Britain’s Masefield; the US-based Bayoil; Trafigura and Vitol from the Netherlands;35 the National Iranian Oil Company;36 as well as several local companies including Yukos Petroleum, Litex and Elpida-3.37 Neftochim’s product mix included more than 50 items. Divided into three major groups, fuels accounted for 89 per cent of the refinery’s sales in 1998, while polymers accounted for 6 per cent and petrochemicals for 5 per cent. The leading item in the refinery’s portfolio was diesel fuel, which accounted for over a third of Neftochim’s sales, followed by fuel oil (24 per cent), gasoline (21-23 per cent), LPG (4.9 per cent) and kerosene (4 per cent).38 A few months before privatization, the company released 0.05 per

Figure 1. Bulgaria and the Neftochim refinery

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cent sulphur-diesel fuel, meeting EN590 European standards. Meanwhile a process of shifting away from Neftochim’s most popular A-91 leaded gasoline had started in favor of unleaded and higher octane gasoline. Despite significant problems surrounding Neftochim, it had several strengths that made it an attractive target for acquisition. First, its location was deemed to be highly favorable for prospective investors. Located close to Bulgaria’s largest port Bourgas on the Black Sea, it provides convenient access for Russian crude and for exports to neighbouring and more distant markets. In addition, due to its strategic location, Neftochim could potentially benefit in case of the realization of oil pipeline projects, such as Bourgas-Vlore or BourgasAlexandroupolis. Second, its strategic position in the overall Bulgarian economy secures significant leverage for the owners of the refinery. In 1998 it accounted for over 14 per cent of Bulgaria’s GDP and for 8 per cent of the country’s total exports.39 Moreover, for years, it had contributed over a quarter of the revenue of the national budget. Third, its infrastructure is highly efficient. It receives crude feedstock from the Rossenets sea terminal via a 15km pipeline near the Bourgas port. Having control over the terminal, provides it with a lowcost structure for the transportation of crude and fuels. In addition, it controls a pipeline network connecting the refinery with storage and distribution terminals in various parts of the country. Finally, by 1999 Neftochim had acquired a near monopoly position in the Bulgarian market. The country’s other refinery, Plama, had been on the verge of bankruptcy and unable to operate for most of the 1990s. Nor did its privatization in 1996, when Euroenergy bought 75 per cent of the refinery, succeed in reviving it.40 In fact, a former chairman of Plama’s board of directors, Boris Kurshev, bluntly noted that the refinery’s prospects could not be expected to improve. It was built under communist central planning with

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the hope of enhancing Bulgaria’s energy security due to the refinery’s inland location. Built in the Pleven region, a city about 174km north-east of Sofia, it was built largely as a result of misplaced hopes about significant crude reserves in that region. Eventually only a sixth of its capacity (1.2m tonnes) could be supplied with crude found in the region. As a result it had to rely on crude oil transported by rail from Varna on the Black Sea, which significantly increased its operational costs. Similarly its design to process the more expensive low-sulphur crude further weakened its ability to compete with other refineries.41 Nevertheless the 1990s had been a difficult decade for Neftochim. Following the downturn in the economy, Neftochim’s capacity utilization dropped significantly. In 1995 it utilized 67 per cent of its capacity, which dropped further to 62 per cent, 54 per cent and 50 per cent in 1996, 1997 and 1998 respectively.42 Similar to the experience of many other refineries in Eastern Europe, it was drawn into a vicious cycle created by accumulating debt and an inability to pay for crude deliveries, which contributed to its drop in capacity utilization and further worsened its financial situation. Two problems stood at the core of this cycle. For years, the government had not liberalized fuel prices. As a result, quite often, Neftochim had to sell its fuels at prices well below their cost of production. This problem became especially grave in 1996 and early 1997 when the country, led by the Socialist government, entered a phase of hyperinflation. Several attempts to raise Neftochim’s wholesale fuel prices failed to match the inflation rate. To make matters worse, the management of the refinery was frequently involved in shady crude delivery deals. An audit, conducted by the finance ministry of the newly elected Kostov government in mid-1997, revealed that Neftochim did not ask crude suppliers to go through a tender process. As a result the refinery paid above average prices for its crude deliveries.43 Due mainly to these

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two problems, the company from the beginning of 1996 to the middle of 1997 incurred losses of 371bn lev ($203m at the then prevailing exchange rate).44 Also, it ran up a huge backlog of taxes owed to the state and outstanding debt to crude delivery companies.45 Among the latter, Neftochim’s debts to Rosneft alone had gone up to $100m by May 1997.46 Yet political changes in early 1997 sparked major changes surrounding Bulgaria’s main refinery. The collapse of the socialist government, partly contributed to by the fuel crisis of the winter of 1996-97, led to the formation of an interim government headed by Sofia’s mayor Stefan Sofianski. Until this government was replaced by Ivan Kostov’s Union of Democratic Forces, the leading party of the elections in the summer of 1997, the interim government took several emergency measures. One of its first decisions was to replace the refinery’s board of directors.47 Following this, it approved a scheme prepared by the Bulgarian Privatization Agency, which called for selling up to 75 per cent of the refinery to a strategic investor.48 Additionally in May 1997, the cabinet opted in favor of liberalizing fuel prices, which provided Neftochim with the authority to determine the prices it would charge, as well as retailers’ margins.49 Taking office in the summer of 1997, the new government took further steps aimed at revitalizing the refinery. Following an audit by the finance ministry, the Bulgaria’s prosecutor-general charged several key officials associated with Neftochim for contributing to its financial collapse.50 Meanwhile, it decided to delay the privatization of Neftochim at least until the end of 1998, in order to allow time for the financial stabilization of the refinery. Government officials believed that this would help to attract investors on better terms.51 Following these decisions, Neftochim’s financial situation was significantly improved. By the end of 1997, its outstanding debt for crude oil deliveries were

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reduced to $18m.52 In 1998, the company recorded a net profit for the first time since 1993, which amounted to $50m.53 Concurrently, there was a sharp rise in exports, especially to the former Yugoslavia. While up until 1996 the refinery had being only exporting only 10-15 per cent of its output, this rose to about 35 per cent over the period 1997-98.54

The privatization of Neftochim Political changes in 1997 provided a major boost for initiating the privatization process of Neftochim. In January 1998, Bulgaria’s Privatization Agency signed a contract with an international consultant (Arthur Andersen) on the privatization of several major assets, among them Neftochim and Bulgaria’s main retail outlet owner, Petrol AD. This was followed by lengthy debates on the design of the privatization of Bulgaria’s petroleum sector, involving mainly the Privatization Agency, the Commission for the Protection of Competition, the Ministry of Industry and officials from Neftochim. The major question was whether to sell Neftochim and Petrol AD to a single strategic investor or to privatize them separately. For the two main players in the privatization of both companies, LUKoil and Yukos Petroleum,55 acquiring both assets simultaneously was the preferred choice. However, the whole decision process was skewed by considerations about the prospective monopolization of the Bulgarian petroleum sector by a private company, as well as by the personal interests of leading personalities in the Bulgarian government. On the one hand, the head of the Privatization Agency, Zakhari Zheliazkov, believed that the two companies should be sold through a separate privatization process and that ownership under a single investor should be avoided. The consultant company, Arthur Andersen, endorsed this view, believing that

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SALE OF NEFTOCHIM

LUKoil

Balkan Petroleum Consortium

Logomat Services

Timeline:
January 1998 – Privatization Agency signed a contract with Arthur Andersen on the privatization of Neftochim.
March 1999 – Privatization Agency prepared a scheme on the sale of a 58% stake in Neftochim to a strategic investor.
April 1999 – Submission of first bids: LUKoil, Yukos Petroleum and Logomat Services.
July 1999 – Submission of improved bids by same bidders.
August 1999 – LUKoil selected by the Privatization Agency as the preferred buyer of Neftochim.
August-September 1999 – Financial assessment of the refinery by LUKoil.
October 1999 – Purchase of a 58% stake in Neftochim completed.

Figure 2. The sale of Neftochim

Bulgaria needed to privatize Petrol AD prior to the sale of Neftochim. On the other hand, one of the leading authorities in the Bulgarian economy, the deputy prime minister and minister of industry, Alexander Bozhkov, supported the idea of having a single privatization deal for both Petrol AD and Neftochim. Allegedly, the former was in favor of Yukos Petroleum, while the latter was supporting LUKoil.56 Following cumbersome debates within the Privatization Agency, the decision was in favour of holding two separate privatization deals for Neftochim and Petrol AD, so balancing competing interests in the privatization process. The decision did not eliminate the possibility of a single investor buying both companies. In the meantime it enhanced the opportunity for political intervention in each of the two deals. By March 1999, the Privatization Agency finally prepared a detailed scheme for selling 58 per cent of Neftochim, and set 7 June as the deadline for the acceptance of offers by potential bidders. Four companies expressed interest in the deal.

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LUKoil offered $77m in cash and $222m in future investments. It declined as part of its offer to inherit all of Neftochim’s debt, but left the door open for further negotiations on this issue. Yukos Petroleum appeared as LUKoil’s biggest competitor. It had been one of the major crude providers to Neftochim since 1997 through which it had established close ties with the Bulgarian refinery and with the energy bureaucracy in Bulgaria and Russia. Its representatives rushed to Moscow to find support for their Bulgarian bid. At this point, the involvement by the Russian bureaucracy was significant. In April 1999, under the guidance of the Russian fuel and energy ministry, Yukos Petroleum entered into an agreement for the establishment of a consortium with several other Russian companies. Thus the Balkan Petroleum Consortium was established under the auspices of the Russian Federation Council. The partners of Yukos Petroleum were Petrol Holding Group from Bulgaria and the

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Russian companies Rosneft, Slavneft, Transneft, Stroytransgaz, Orel Oil and Yuden Technology Ltd.57 The mission of the consortium was defined as bidding for the Neftochim refinery in Bulgaria, as well as potential cooperation in the construction of the projected oil pipeline from Bourgas to Alexandroupolis. Following the consortium’s creation, it emerged as the primary rival to LUKoil in the bid for Neftochim. Its offer consisted of a symbolic $1, a commitment to invest $344m over the following five years and a willingness to negotiate on a schedule for repayment of Neftochim’s debt by 2003.58 The Cyprus-based Logomat Services appeared as the third competitor for Neftochim. It was backed by Andrei & Cie, a Swiss trading company, which was involved in the management of Bulgaria’s other refinery Plama. It offered $30m in cash with a commitment to invest $165m.59 There was also a fourth competitor, the Turkish company Akmaya, which had previously participated in the privatization of one of Romania’s major refineries, Petromedia. However, it failed to submit its offer on time and was disqualified. Yet none of the offers were found satisfactory by the Privatization Agency, which in turn asked the participants to improve their bids for resubmission by 20 July 1999. While the companies prepared for the next round of bidding, Yukos Petroleum witnessed a major setback, when suddenly Rosneft and Slavneft announced their decision to leave the Balkan Pipeline Consortium.60 While no official explanation was provided, the companies were allegedly discouraged by the Russian fuel and energy ministry, when it decided to make these state-run companies increase crude oil deliveries to their own refineries. Further rumours circulated at the time that LUKoil’s lobbying of the Russian fuel and energy ministry successfully reversed its generally negative position on the acquisition.61 Despite the departure of two of the major Russian members of the consortium, Yukos Petroleum decided to continue with its bid.

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Its financial resources were never clear and it was widely believed that its head, Mitko Subov, had the financial backing of the Russian metallurgy magnate Michael Chorni, as well as personalities from Bulgaria’s former national security service, all of whom had accumulated significant fortunes in the 1990s.62 Thus Yukos increased its offer up to $78m in cash. The other two participants, LUKoil and Logomat Services, decided to focus more on the issue of Neftochim’s existing debt. The debt issue had remained quite vague and appeared as a major decisionmaking problem for the bidders. Thus, unlike Yukos Petroleum, Logomat Services and LUKoil requested to proceed with a thorough financial investigation of Neftochim in case of a victory in the bid. Logomat Services preferred to stick with its original bid, while LUKoil announced further improvements in its offer.63 LUKoil offered $101m in cash and committed to invest $268m for the modernization of the refinery by 2005. It also agreed to an in-kind contribution by including an oil deposit in West Siberia into the equity capital of Neftochim. The value of this asset was estimated to be $140m and would secure 700,000 tonnes of crude to the refinery every year.64 Additionally it agreed to assume Neftochim’s existing debt, but only after pursing an investigation process that would determine the exact amount of debt prior to clarifying the terms of repayment. In August 1999, the Privatization Agency selected LUKoil as the preferred candidate in the privatization process.65 As a response to LUKoil’s concern on Neftochim debt, it hinted at the possibility of restructuring part of it. By the end of September 1999, LUkoil completed its new financial assessment of the refinery. Following approvals from the Cabinet of Ministers and from the board of the Privatization Agency, the agency’s chairman, Zakhari Zheliazkov, and the head of LUKoil Petrol Bulgaria signed

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the agreement finalizing the purchase on 12 October. The contract secured LUKoil’s 58 per cent of the refinery.66 The state kept a socalled ‘golden share’, which aimed to protect Bulgarian national interests. It secured a major role for the state on several vital issues, such as the potential liquidation of the refinery, the halting of its production process, maintaining access to port facilities and product pipelines, and overseeing any changes in Neftochim’s articles of association.67 The buyer undertook to take over the refinery’s debt of nearly $400m, but the state committed to rescind a significant part of it, namely under the terms of legislation associated with a law on settling non-performing credits of state-owned companies to banks. Thus within about a week after the contract was signed, the Cabinet of Ministers agreed to rescind $172m of Neftochim’s total debt.68

Neftochim under LUKoil’s ownership LUKoil Neftochim was the new name of the Bulgarian refinery following privatization. The company’s management was confirmed towards the end of 1999, when Valentin Zlatev was chosen as managing director. He had been representing Russian interests in Bulgaria since the mid-1990s. He had served as the vice-president of Rosneft and the head of the Rosbulneft joint venture between the Russian company and Neftochim. 69 Under his leadership, Rosneft emerged as one of the primary suppliers of the Bulgarian refinery. During the privatization process of Neftochim and the retailer Petrol AD, he represented LUKoil and headed its subsidiaries in Bulgaria, LUKoil Bulgaria and LUKoil Petrol. Meanwhile, LUKoil’s first vice-president, Ralif Safin, was elected as the chairman of the refinery’s supervisory board.

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Before launching new investment in the refinery, its new owner announced its plan to reverse former policies about crude supply. A few weeks before the LUKoil acquisition, its representatives in Bulgaria released information that emphasized the importance of avoiding intermediaries in crude supply deals. The company had estimated that LUKoil would be able to deliver crude to Neftochim at a price about 50 per cent below that offered by intermediaries.70 As a result, starting from January 2000, the company announced that it would start processing crude delivered solely from LUKoil.71 This contributed to a major conflict with Petrol AD’s new owners, which had been accustomed to lucrative crude supply deals with Neftochim (see next chapter). The privatization of the Bulgarian refinery provided a boost to its modernization process. Based on its privatization commitments, LUKoil Bulgaria had invested $252m by the end of 2004 and paid Neftochim’s outstanding debt of $207m. Its investments were aimed mainly at modernizing the catalytic cracking and catalytic reforming units of the refinery. Additionally the company launched a major investment programme in retail outlets, opening 120 retail stations at the cost of nearly $103m.72 In late 2004, Vagit Alekperov announced LUKoil’s plans to invest a further $350m-$400m in Neftochim by 2012.73 The goal in the first phase of the plan is to have all gasoline production fully reach EU standards before the end of 2008. For that purpose, LUKoil has slated $40m for the purchase of a new isomerization unit. The second phase of the plan, ending in 2012, envisages the purchase of new deep-processing and desulphurization units at the cost of nearly $300m.74 Within this plan, LUKoil managers consider 7m tonnes of crude as the optimum volume for annual processing, though on average it has processed about 5.5m tonnes a year since LUKoil’s takeover.75

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Neftochim’s privatization has had relatively favorable implications on the refinery’s profitability. Thus, during the first year of operation under LUKoil’s control, the Bulgarian refinery generated a profit of $51m.76 However, a sharp drop in its profitability was experienced in the years following as a result of a reorganization within LUKoil Bulgaria. In 2001, LUKoil Neftochim decided to enter into a processing agreement with Litasco, another subsidiary of LUKoil registered in Switzerland. As a result the advantageous fuel trade arrangement was no longer within the activity profile of LUKoil Neftochim, which sharply reduced the refinery’s profitability. LUKoil Neftochim’s profitability fell to $2.5m (3.8m lev) in 2001 and $2.7m (4.1m lev) in 2002, Thereafter LUKoil Neftochim’s profits reached $36.3m (54.8m lev) in 2003 and dropped again to $11.5m (17.4m lev) in 2004.77 LUKoil officials attributed the drop in profits in 2004 to the depreciation of the dollar, but most likely it was an outcome of the ongoing reorganization within the

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company and its subsidiaries. The size of LUKoil Neftochim in terms of turnover and profits is comparatively low by international standards. Yet the company remains the largest tax payer in Bulgaria, which raises its strategic value in the Bulgarian economy. In 2003, it paid about 1.2bn lev in taxes, which accounted for about a quarter of Bulgaria’s overall budget revenues.78 LUKoil’s determination to keep this asset is probably best illustrated by its consecutive attempts to acquire 100 per cent ownership of the refinery. In October 2004, following a decision to consolidate all of LUKoil’s European assets, 58.4 per cent of LUKoil Neftochim’s shares were transferred to LUKoil Europe Holding, its subsidiary based in the Netherlands. Subsequently, through share purchases, LUKoil Europe Holding’s share in LUKoil Neftochim reached 93.25 per cent at the beginning of 2005. The company has extended an offer to shareholders for the purchase of the remaining shares of LUKoil Neftochim.79

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4. Russian involvement in Bulgaria’s fuel market privatization y the early 1990s, Bulgaria’s wholesale and retail fuel market was monopolized by a single company, Petrol AD. The collapse of the communist regime led to a sudden growth in privately owned fuel companies, some of which got involved in wholesale along with retail services. But Petrol AD was able to preserve its dominant role in the Bulgarian fuels market up until its privatization in 1999. At that time it owned 450 retail outlets out of a total of 1,300 service stations in Bulgaria (as of the end of 1998). Its sales accounted for nearly 26-28 per cent of the national fuel market. With a large network of warehouses, it had a dominant role in wholesale as well.80 Due to its dominant market share, Petrol AD appeared as the biggest prize in Bulgaria’s fuel market privatization. This section starts with a detailed analysis of the privatization process of the company. Particular emphasis is given to the question of Russian involvement in this privatization deal. The latter parts of the section evaluate the state of Petrol AD, as well as the Bulgarian fuel market overall, following the privatization process.

B

Petrol AD’s privatization The first steps towards Petrol AD’s privatization were taken in the mid-1990s under an initiative for mass privatization. A quarter of Petrol AD’s shares were sold to private investors and privatization funds. Eventually most of these shares (24.2 per cent) ended up in the hands of one of the

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funds, which in 1997 was reorganized into a company named Petrol Holding Group, which would emerge as one of the major bidders for Petrol AD’s remaining shares. With the rise of a new government in the summer of 1997 debates on the sale of Petrol AD’s remaining 75 per cent shares intensified. At the beginning of 1998, Bulgaria’s Privatization Agency launched a new programme which aimed to sell 51 per cent of Petrol AD. It set 19 October as the deadline for the acceptance of first offers. Several companies showed immediate interest. These were Yukos Petroleum, Petrol Holding Group, Rosneft International, Austria’s OMV and Turkey’s Park Holding. A major battle between the first three companies quickly ensued. A brief overview of their involvement in Petrol AD’s privatization reveals two major characteristics. First, all had benefited from some rather non-transparent deals in Bulgaria’s fuels market in the past. Through these transactions, Yukos Petroleum and Rosneft International (operating under Rosbulneft) had emerged as significant players in Bulgaria’s wholesale fuel market. They had benefited from shady deals within a triangular relationship involving themselves, the Neftochim refinery and Bulgarian retailers. They secured a number of overpriced crude supply contracts for the Neftochim refinery, as well as fuel purchase contracts from the refinery at set artificially low prices. These fuels were delivered to Bulgarian retailers, especially to Petrol AD, at exceedingly high margins.81 Petrol

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Holding Group remained involved in these deals as a shareholder in Petrol AD. However, its autonomy was restricted due to the limited share ownership in Petrol AD. A second major aspect of Petrol AD’s privatization was the presence of companies with affiliations that were perplexing for most observers at the time. The common pattern was for a given company to operate under the name of a well-known

Russian company without having any documented ties to them. At the time of Petrol AD’s privatization, Yukos Bulgaria had no ties with Russia’s Yukos and Rosneft International was not affiliated with Russia’s Rosneft. In fact, the Yukos president, Mikhail Khodorkovsky, expressed his discontent about Yukos Bulgaria using his company’s brand name.82 Even more perplexing, Yukos Bulgaria represented the interests of

SALE OF PETROL AD

Consortium: LUKoil and Rosneft International

Yukos Petroleum

Consortium: Petrol Holding Group and OMV

International Consortium Bulgaria Timeline:
January 1998 – Privatization Agency signed a contract with Arthur Andersen on the privatization of Petrol AD; 51% of the company’s shares designated for sale to a strategic investor.
October 1998 – Submission of first bids: Yukos Petroleum; Park Holding; and a consortium between Rosneft International, Petrol Holding Group and OMV.
February 1999 - Submission of improved bids: consortium of LUKoil-Rosneft International not admitted to bid; other bidders are Yukos Petroleum and a consortium between Petrol Holding Group and OMV.
March 1999 – Yukos Petroleum designated by the Privatization Agency as the ‘exclusive buyer’ of Petrol AD.
April 1999 – International Consortium Bulgaria established by Yukos Petroleum and its former competitors Petrol Holding Group and OMV.
July 1999 – Sale of Petrol AD to Yukos Petroleum and the transfer of its shares to International Consortium Bulgaria approved by the Commission for the Protection of Competition.
August 1999 – Purchase of 51% stake in Petrol AD completed.

Figure 3. The sale of Petrol AD

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Russia’s Rosneft, while Rosneft International was in fact affiliated with LUKoil.83 Nevertheless Russian involvement in Petrol AD’s privatization, though often disguised, was quite significant. Yukos Bulgaria, registered in Bulgaria’s coastal city Varna in 1995, had significant ties with businessmen from Russia. One of its founders was Denis Dzhersov, a Lithuanian citizen, who had worked previously in Yukos’ Moscow office. The company operated mainly through a Bulgarian citizen, Mitko Subev, who had developed a prospering business in the 1990s through crude supply contracts with Neftochim. He benefited from close ties with the socialist government, as well as with key officials in the Kostov government after 1997.84 Reportedly the person behind Yukos Bulgaria was the mettalurgy magnate Michael Chorni,85 however his name was not on the official list of company’s board members. Chorni had already established a significant presence in Bulgaria’s wireless communications, media and banking sectors, and now he had turned his attention to the country’s oil business. The other company, Rosneft International, also had significant Russian involvement. Curiously it was headed by Valentin Zlatev, who held his position in the company even after becoming the head of LUKoil Bulgaria. Moreover Zlatev remained as the head of the Rosbulneft joint venture when he was instructed to direct LUKoil’s acquisition initiatives regarding Petrol AD and Neftochim. Allegedly, following Zlatev’s departure from Russia’s Rosneft in 1998, LUKoil capitalized on his social capital, based on his leading role at both Rosbulneft and Rosneft International. Russia’s Rosneft, on the other hand, cut its ties with Neftochim and its role in Rosbulneft.86 The pieces in the ‘who’s who?’ puzzle in Petrol AD’s privatization started to fall into place once companies started to submit their offers. Three bidders appeared in the initial round: Yukos Petroleum, Turkey’s Park Holding and a consortium consisting

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of Rosneft International, Petrol Holding Group and Austria’s OMV.87 The Privatization Agency responded to all offers with a call for improved bids to be submitted by 12 February 1999. While preparing for the second round, the consortium established by Rosneft International, Petrol Holding Group and OMV dissolved. Based on a loophole in the law, the consortium was registered after the first bidding round when Petrol Holding and OMV decided to collude against Rosneft International. It was at this point that LUKoil decided to join the race openly and established a consortium with Rosneft International. However, the Privatization Agency insisted that LUKoil was not eligible to join the bidding as it was not one of the original bidders on 12 October. Amidst accusations about the Privatization Agency being biased in favour of Yukos Petroleum, LUKoil disclosed that Rosneft International would represent its interests in the process and that it would pursue a consortium on this basis.88 In the meantime, the puzzle regarding the identity of the participant companies started to clarify when Russian deputy minister of energy and fuel, Sergei Chizhov, arrived in Sofia. This occurred immediately after the submission of the improved bids, which were now left awaiting the evaluation of the Privatization Agency. Allegedly, the Russian ministry of fuels and energy, headed by Sergey Generalov, was in conflict with LUKoil amidst rising debate over the creation of a united state-owned oil company bringing together Rosneft, Slavneft and Onaco. In particular parts of the Onaco assets were sought by LUKoil.89 LUKoil sources claimed that Chizhov’s visit was sponsored by Michael Chorni, who held shares in Yukos Bulgaria.90 During the visit, Chizhov openly announced that Yukos Petroleum represented Rosneft’s interests in Bulgaria.91 It appears the plan was to win the privatization deal for Petrol AD in the name of Yukos Bulgaria, which the

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Bulgaria prospective new state oil company would subsequently acquire.92 LUKoil, on the other hand, acquired support from the Russian ambassador in Sofia, Leonid Kerestedzhiiants,93 who requested the Bulgarian authorities to allow LUKoil to participate in the privatization deal. On 12 March 1999, the Privatization Agency announced that Yukos Petroleum had been designated as the ‘exclusive buyer’ of Petrol AD based on its offer to pay $52m in cash for the company and to invest an additional $60m in Petrol AD over the following five years. The consortium of Petrol Holding Group and OMV lost the auction as it offered $2m less cash while matching the Yukos commitment for long-term investment. Despite intensive lobbying on the part of LUKoil, the Privatization Agency upheld its decision about LUKoil being an ineligible candidate. It decided to ignore the offer letter sent by its consortium. Subsequently, LUKoil opened the letter publicly in order to demonstrate the superiority of its offer. The LUKoil-Rosneft International consortium had offered to pay $61m in cash and invest $147m in the following five years.94 The supervisory board of the Privatization Agency, however, decided to postpone its decision on approving the deal with Yukos Bulgaria. Suddenly debates about the potential implications of Petrol AD’s sale on the privatization of Neftochim and fears regarding the monopolization of the Bulgarian fuel market by Yukos Petroleum gripped major political offices, such as the ministries of industry, finance and trade, as well as the Privatization Agency.95 This was partly prompted by a memorandum concerned with the privatization of Neftochim issued by the Privatization Agency in March 1999. Yukos Bulgaria’s victory in Petrol AD raised immediate concerns about prospects of having Neftochim under its control as well. LUKoil’s active lobbying activities in the meantime also contributed to the decision of the Privatization Agency to postpone the approval of the Petrol AD deal. In April 1999, LUKoil’s president, Vagit Alekperov, flew to Sofia to reiterate his company’s inter-

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ests in the acquisition of Petrol AD and lobbied for holding another round of competition. He met the Bulgarian president, Petur Stoyanov, the prime minister, Ivan Kostov, and the deputy prime minister, Evgenii Bakurdzhiev.96 Alekperov’s visit was followed by a sudden onslaught on the part of the Russian government to coordinate Russian involvement in the Bulgarian petroleum downstream market. On the one hand, following intensive involvement by the Russian energy and fuel ministry, the Balkan Petroleum Consortium was established for the purpose of bidding on Neftochim (see above). On the other hand, Yukos Petroleum’s victory in the privatization of Petrol AD was still not assured, which became increasingly worrying for Yukos Petroleum as well as for certain parts of the Russian bureaucracy. This in turn resulted in the establishment of another consortium that united the two competitors for Petrol AD: Yukos Bulgaria on the one hand and the consortium of Petrol Holding Group and OMV on the other. The three companies established a new consortium named International Consortium Bulgaria (ICB). Yukos Petroleum was accorded 50 per cent plus two shares in it, while the rest of the shares were divided equally between Petrol Holding Group and OMV.97 The new entity notified the Privatization Agency about the decision to transfer Yukos Bulgaria’s rights and obligations to the consortium in case of a final approval on the Petrol AD deal. Eventually, the Privatization Agency agreed to confirm the victory of Yukos Petroleum, as well as its right to transfer its shares to ICB. Final approval came in July 1999 from the Commission for the Protection of Competition. Despite concerns about the prospective monopolization of the Bulgarian fuel market, it decided to endorse the deal. However, in order to protect the interests of the prospective owner of the Neftochim refinery the approval came with one caveat. Accordingly Petrol AD was

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obliged in the following three years to purchase fuels from the Bulgarian refiner at volumes equivalent to those in the preceding years.98 ICB paid the promised $52m in cash on 3 August 1999, when it officially became the owner of the 51 per cent stake of Petrol AD.99 Given that one of the members of ICB, Petrol Holding Group, had already acquired 24.2 per cent of Petrol AD, the total share of the consortium members in the Bulgarian distributor came up to 75.2 per cent.100

Petrol AD after privatization Following the approval for Petrol AD’s privatization, the major focus in the Bulgarian petroleum sector turned on Neftochim. As LUKoil won this time, this had a major implication on the sector overall. Suddenly two staunch rivals, LUKoil and Yukos Petroleum (through its dominant role in the ICB), needed to find a mutually satisfying solution to their rivalry. A truce, however, did not come until the middle of 2001. Over this period, Yukos Petroleum’s management (renamed Naftex Bulgaria Holding) refused to purchase most of its fuels from LUKoil Neftochim in violation of the privatization contract. Weak judicial enforcement of the terms of the contract and the negligible cost of penalties encouraged ICB to import fuel mainly from Romania’s Petromedia refinery. As a result LUKoil’s market share in Bulgaria’s fuel market shrank and the Russian company was forced to look at other foreign markets. A compromise was finally reached in 2001, when Naftex Bulgaria Holding agreed that it would market fuels exclusively from LUKoil Neftochim in its retail outlets for the following 15 years. The two companies also agreed to cooperate in expanding their share of Bulgaria’s retail market by LUKoil agreeing to invest in about one hundred of Naftex’s retail outlets.101 In addition, LUKoil conceded that Naftex could deliver crude to Neftochim based on mutual negotiations.

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Once Petrol AD was privatized, Russian involvement in the company became even more obscure. On the one hand, plans regarding the establishment of a major state-owned Russian oil company were suspended. As a result there has been no further evidence about Rosneft’s (or Slavneft’s) attempt to penetrate the Bulgarian market through its ally Yukos Petroleum. On the other hand, the lack of transparency about the structure of ownership in Petrol AD, as well as confusion created by frequent reorganizations of the company, have helped to conceal the real extent of Russian presence in Bulgaria’s major fuel distributor. Soon after the privatization of Petrol AD was concluded, all of Yukos Petroleum’s business was transferred to Naftex Bulgaria Holding. It was registered as a subsidiary of the Vienna-based Naftex Group. Subsequently, it acquired the shares of Petrol Holding Group in the ICB, as well as the shares of OMV by transferring 25 of Petrol AD’s retail outlets to the Austrian company. In 2003, the name of Naftex Bulgaria Holding was changed to Petrol Holding.102 Based on an audit conducted for Petrol AD in September 2004, Petrol Holding controlled 92.57 per cent of the shares of Petrol AD. It directly controlled 70.57 per cent of Petrol AD’s shares and another 22 per cent through Ros Oil, another subsidiary based in Varna.103 With regards to Petrol Holding itself, Bulgarian sources identified four personalities that control the company. As of late 2004, an Austrian citizen Friedrich Zaufal held 57.75 per cent of the holding company’s stakes, Mitko Subev held 25 per cent, while Russian citizens Andrey Arzhanov and Alexander Melnik held 15.75 per cent and 1.5 per cent respectively.104 Remarkably the names of executives tied to Yukos Petroleum (such as Denis Ershov and Michael Chorni) are missing. This is mainly the result of an initiative carried out by Bulgaria’s intelligence services aimed at fighting organized crime. In mid-2000, the head of the

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Bulgarian intelligence services publicly announced that five Russian businessmen (with Denis Ershiv and Michael Chorni included in the list) were banned from entering Bulgaria for ten years. The five Russians were charged for posing a threat to Bulgaria’s national security.105 Nevertheless a major change in Petrol AD’s ownership structure appeared on the horizon towards the end of 2004. LUKoil Bulgaria started negotiations with Petrol Holding on the sale of an initial 18.3 per cent stake in Petrol AD to the Russian major.106 Subsequently, LUKoil announced its intention to negotiate to acquire Petrol AD fully.

Bulgaria’s fuel sector after Petrol AD’s privatization Four large players had emerged in fuel marketing in Bulgaria by the end of 2004. Representatives from the petroleum industry in Bulgaria assert that no data on market share is available for any of these companies and that all numbers provided by these competing companies should be treated with caution.107 A study compiled by LUKoil Neftochim points out that there were about 3,000 retail outlets in Bulgaria towards the end of 2004: 375 of them were owned by Petrol AD, 120 belonged to LUKoil, Shell had 82 and OMV 69. In terms of the volume of fuel sales, their shares in Bulgaria’s retail market stood as follows: Petrol AD had 17.55 per cent, followed by LUKoil with 12.49 per cent, Shell with 10.47 per cent, and OMV with 8.6 per cent.108 Petrol AD’s sources, however, indicate a larger ownership for the company of 450 retail outlets. Moreover, with its 80 warehouses, the company plays a leading role in the wholesale fuel trade. Its warehouses

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alone account for nearly 70 per cent of the country’s fuel storage capacity.109 Nevertheless LUKoil has decisively entered the Bulgarian market, and, if it succeeds in acquiring Petrol AD, it will undoubtedly secure a dominant position. It is likely that its drive for dominance in the market will encounter anti-trust charges, as Bulgarian legislation limits a single company’s market share to 35 per cent, which will become more relevant as smaller retail outlet owners are gradually displaced by bigger players. Apparently about 30 per cent of the Bulgarian fuel market is still in a grey zone. When this disappears, it will contribute to the consolidation of Bulgaria’s petroleum business among a few major participants.110 In line with Bulgaria’s harmonization of its laws with the EU, consolidation in its petroleum sector will have significant strategic implications. Thus the law on mandatory crude oil and oil product reserves, adopted in 2003, accords a major role to private companies. Articles 17 (1) & (2) of the law require producers and importers of crude and oil products to hold mandatory reserves.111 It aims to secure a 90-day strategic reserve for Bulgaria by 2012. By then, producers and importers of crude and oil products will need to account for 55 days of the strategic reserves. The rest is the responsibility of a government agency in charge of reserves, as well as of the power sector. Based on this law, LUKoil Bulgaria and Petrol AD, whether united under LUKoil’s ownership or not, are expected to enhance their strategic role in the Bulgarian economy. This is a result of LUKoil’s near virtual monopoly position in the production of fuels and Petrol AD’s major role as an importer, as well as its ownership of the largest fuel warehouses in the country.

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5. Conclusions ussia’s hydrocarbon sector has increasingly emerged as one of the ‘soft powers’ in Russian foreign policy-making today. In Eastern Europe and the FSU in particular, where Russia lost most of its previous leverage, hydrocarbons have provided major continuity in Russia’s relations with its neighbours. Most of these countries have maintained their reliance on Russian crude oil and gas, and few have alternatives on the horizon. The drive of Russian oil companies to acquire various assets in foreign countries has emerged as a major factor augmenting Russia’s presence as well as leverage in Eastern Europe and the FSU. One of the main questions addressed has focused on the reasons behind this drive. The study reveals that a uniform explanation does not suffice as Russian companies have exhibited different growth strategies and have shown diverging interests in acquisitions beyond Russia’s borders. While every Russian company has benefited from the boom in Russia’s petroleum sector and from record-braking crude prices of the past few years, LUKoil had already completed the acquisition of several major assets prior to this upturn. Nevertheless several factors can be identified as instrumental in driving Russian companies abroad. The urge of Russian majors for vertical integration in the context of limited infrastructure for exporting crude oil has been a primary reason behind Russian penetration in Eastern Europe and in some cases in the FSU. As long as export infrastructure is limited, given the size of Russia and the cost of transporting refined products from remote locations, most Russian oil majors will maintain the urge to integrate vertically

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through downstream and mid-stream acquisitions in the European heartland. Concurrently the comparative advantage that Russian majors had in their foreign acquisitions in Eastern Europe and the FSU has gradually subsided. The initial drive towards privatizing the petroleum sector in these regions created enormous opportunities for Russian companies. But privatization is almost complete in most of these countries with few assets remaining for sale. Moreover the success of Russian majors has been mainly in those countries that experienced serious economic difficulties coupled with the presence of nearly bankrupt downstream companies. Russian success is much less apparent, for instance, in countries such as Hungary, the Czech Republic and Poland. However the foreign acquisition drive of Russian majors in these regions is hardly over. If Russian oil companies decisively follow western majors in terms of increased transparency and growth in the rate of capitalization, they may soon become eligible to acquire more major assets. Takeover of the assets of regional downstream companies (such as OMV, PKN and MOL) or those of international oil majors cannot be precluded. Another major question addressed in the study has been on the role of the Russian government in the foreign expansion of their oil companies. As the case study on Bulgaria has illustrated, the Russian government did promote Russian involvement, but this support was hardly coordinated. On the contrary, Russian companies in Eastern Europe and the FSU have often competed with each other, bidding up the price of the requested asset.

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Yet the lack of coordination in the Russian government was mainly a characteristic of the early stage of Russian oil majors’ expansion abroad. During this period, companies such as LUKoil designed strategies with little regard for the priorities of the weak Russian state. Today the pendulum has swung in favor of the state with the Russian president being a chief proponent of having Russian oil

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companies submit to the state and to attend to its interests. Consequently future expansion of Russian companies will most likely be subjected to a higher level of coordination by state authorities. Moreover Putin’s perception of the hydrocarbon sector as a potential instrument of Russian foreign policy-making indicates that the state’s role may go beyond coordination.

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Notes and references 1

2 3

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5 6 7

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9 10 11

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13 14 15 16 17

18 19

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Major exceptions are LUKoil’s acquisition of Getty Petroleum’s gas stations in the East Coast of US; its purchase of a further 795 gas stations from ConocoPhillips in the states of New Jersey and Pennsylvania at the beginning of 2004; and its March 2005 acquisition of Oy Teboil Ab and Suomen Petrooli Oy, major owners of fuel retail outlets and wholesalers of refined products in Finland. ‘Growth comes at a price in Eastern Europe’, International Petroleum Finance, 4 September 2003. Concluded among countries in Eastern and Central Europe, CEFTA called for rapid removal of trade barriers amongst signatories. Its signatories include Poland, the Czech Republic, Slovakia, Slovenia, Hungary, Bulgaria and Romania. Oktay Movsumov, ‘Investitsionny Rezhim v Neftiannom Sektore Toplivo-Energeticheskogo Kompleksa Bolgarii’, Investments in Russia, 20 January 2002. Christo Stoianvo, ‘Neftochim Reports BGN 4m 2002 Report’, Pari, 21 March 2003. Svetlana Babaieva, ‘Vagit Alekperov: Neftianaia Otrasl Vyzdorovela’, Izvestia, 28 June 2001. Lada Klokova, ‘Grecheskaia Grust - Rossiiskie Neftianye Kompanii Zainteresovalis Zarubezhnymi Proektami’, Delovaia Khronika, 30 April 2002. ‘Ekspansiia Prodolzhaetsia – LUKoil Khochet Kupit Neskolko NPZ v Evrope’, Vedomosti, 21 February 2005. ‘V. Alekperov: ‘Na Yuge Evropy Nas Interesuet Vse’, Kommersant Daily, 9 August 2003 ‘Rossiiskie Neftianiki na Rynkakh Dalnego Zarubezha’, CCPR Analytical Report, 26 June 2002. ‘Perspektivy Razvitiia Rossiiskoi Neftegazavoi Ekspansii za Rubezh’, CCPR Analytical Report, 26 June 2002 Lada Klokova, ‘Grecheskaia Grust - Rossiiskie Neftianye Kompanii Zainteresovalis Zarubezhnymi Proektami’, Delovaia Khronika, 30 April 2002. ‘Russia oil sector report’, Troika Dialogue Research, March 2000. www.lukoil.ru. Svetlana Babaieva, ‘Vagit Alekperov: Neftianaia Otrasl Vyzdorovela’, Izvestia, 28 June 2001 ‘LUKoil buys 51 per cent of Petrotel’, Daily News (Romania), 3 February 1998. ‘Russian oil companies control over 50 per cent of Ukraine’s petroleum products market’, CIS Oil and Gas Report, 29 December 2000. ‘Russia’s LUKoil company wins control over oil refinery in Odessa’, Infobank, April 1999. Elizabeth LeBras, ‘LUKoil blazes American trail with purchase of gas stations’, The St. Petersburg Times, 7 November 7, 2000 (http://www.sptimes. ru/archive/times/618/news/b_761.htm).

20 ‘LUKoil doubles its presence on the US gasoline retail market’, Capital Link – Russian Press Releases. 27 January 2004, (http://www.capitallinkrussia.com/ press/companies/50010142/26482.html). 21 ‘LUKoil outbids MOL for stake in Serbia’s Beopetrol’, Energy Compass, 28 August 2003. 22 Teboil and Suomen Petrooli are affiliated: Teboil responsible for marketing and sales, and Suomen Petrooli responsible for imports and logistics. 23 ‘LUKoil gets sole control over Finnish Oy Teboil Ab and Suomen Petrooli Oy’, http://www.lukoil. com/press.asp?div_id=1&id=2330&year=2005. 24 ‘LUKoil Meniaet Prioritety’, Vedomosti, 15 September 2003. 25 ‘Russia’s LUKoil interested in controlling Poland’s Grupa Lotos’, Prime Tass (English Language Business Newswire), 18 May 2004. 26 ‘LUKoil Meniaet Prioritety’, Vedomosti, 15 September 2003. 27 ‘The oil and gas industry 2000-2004’, Kommersant Vlast, 5 October 2004. 28 ‘Czech Republic: LUKoil sells Czech outlets’, Nefte Compass, 17 December 2003. 29 ‘Russia’s LUKoil tries to buy control of Lithuania’s oil company from Yukos’, BBC Monitoring International Reports, 14 April 2005. 30 ‘Refinement: LUKoil eyes refining facilities outside Russia’, Nefte Compass, 18 February 2004. 31 Ibid. 32 ‘LUKoil plans to raise capacity’, Pari, 11 November 1999. 33 ‘LUKoil aims to be sole supplier to Neftochim after buy-in’, Platt’s Oilgram News, 23 September 1999 34 ‘Rosneft and Neftochim set up Rosbulneft venture’, FT Energy Newsletter – East European Energy Report, 27 October 1995 35 ‘Neftochim reduces debts to $18m’, Pari, 11 December 1997 36 ‘Neftochim steps up throughput’, FT Energy Newsletter – East European Energy Report, 19 March 1996. 37 ‘Neftochim contracts supplies from Elpida 3 amid domestic glut’, FT Energy Newsletter – East European Energy Report, 27 March 1995 38 Ibid. 39 ‘Neftochim’, Elana Inc Brokerage and Trading, 1 March 2000. 40 ‘Nova Plama Otonova pod Zaplakha ot Falit’, Banker, 15 October 2004. 41 Boris Kurshev, ‘Iska li Nova Plama da Raboti’, Kapital, 5 August 2002. 42 ‘Neftochim company profile’, First Financial Brokerage House, January 2000. 43 ‘News briefs - Bulgaria’, Platts Oilgram News, 29 July 1997.

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44 Ibid. 45 Galina Alexandrova, ‘Sudbata na Neftochim se Reshava v Rusiia’, Kapital, 20 April 1998. 46 ‘News Briefs – Bulgaria’, Platts Oilgram News, 2 May 1997. 47 ‘News Briefs – Bulgaria’, Platts Oilgram News, 6 March 1997. 48 ‘Bulgarian shortages prompt prices’, FT Energy Newsletter – East European Energy Report, 31 March 1997. 49 ‘Bulgaria frees liquid fuel prices but gas causes rows’, FT Energy Newsletter – East European Energy Report, 28 May 1997; and ‘KZK Nakazva Neftochim za Monopolno Opredeliane na Tsenite’, Kapital, 22 September 1997. 50 Five officials were charged, who had held ministerial or executive positions during the previous government. Neftochim’s former general manager Stefan Nedeltchev was among them. See: ‘News Briefs – Bulgaria’, Platts Oilgram News, 22 December 1997. 51 ‘Bulgarian refinery sale off for a year of revamp’, Platts Oilgram News, 26 August 1997. 52 ‘Neftochim reduces debts to $18m’, Pari, 11 December 1997. 53 ‘LUKoil Poe Upravlenieto na Neftochim’, Kapital, 6 December 1999. 54 ‘Neftochim company profile’, First Financial Brokerage House, January 2000. 55 A Bulgarian company with no links to the Russian oil company Yukos. 56 Kalin Dimitrov, ‘LUKoil Izgubi Bitkata za Petrol’, Dnevnik, 25 January 1999; and Galina Alexandrova and Miglena Mancheva, ‘Sporut za Petrol i Neftochim Izvadi Nayave Lobitata na Kupuvachite’, Kapital, 25 January 1999. 57 ‘Podpisanie Soglashenie o Sozdanie Balkanskogo Neftianogo Konsortsiuma Sostoitsia Zavtra v Sovete Federatsii’, Ria-Novosti, 19 April 1999 (http://www. rol.ru/politic/yugoslav/99/04/19_068.htm). 58 Miglena Mancheva, ‘LUKoil i Yukos Petroleum Naddavat za Neftochim pod Uslovie’, Kapital, 28 June 1999. 59 Ibid. 60 ‘Rosneft, Slavneft withdraw from Neftochim privatization’, Platt’s Oilgram News, 23 June 1999. 61 ‘LUKoil Staniet Bolgarskim Monopolistam’, Kommersant, 11 August 1999. 62 Teodora Peeva, ‘Koi Shte Otselee na Petrolnia Pazar v Bulgaria’, Sega, 15 March 1999. 63 ‘Podobreni Oferti za Neftochim Postupiha v Agentsiyata za Privatizatsiya’, Dnevnik, 20 July 1999. 64 Iva Ivanova, ‘Burgaskata Rafineriya shte Prerabotva Sobstven Petrol – Neftochim e Veche v Ruski Rutse’, Pari, 13 October 1999; and ‘LUKoil Vodi za Neftochim’, Kapital, 26 July 1999. 65 ‘LUKoil e Predpochitaniyat Kupuvach na Neftochim’, Dnevnik, 6 August 1999. 66 At the time of signing the privatization contract, the ownership structure for the remaining 42 per cent of the refinery was as follows: about 25 per cent of the refinery’s shares had already been sold to private investors during a mass privatization scheme in 1997; 15 per cent were designated for sale to the refinery’s staff; and the remaining 2 per cent were designated

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67 68 69 70

71 72 73

74 75 76 77 78

79 80

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82

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85 86

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to meet possible restitution claims by former landowners. ‘Bulgaria protected from LUKoil by “Golden Share”’, Vedomosti, 19 October 1999. ‘Bulgaria – Oprostikha Dulgovete po ZUNK na Neftochim’, Pari, 19 October 1999. ‘Rosbulneft s Podnoven Direktorski Bord’, Kapital, 10 November 1997. Based on crude prices in September 1999, LUKoil claimed that intermediaries deliver crude to Neftochim at the price of $140 per ton. In case of direct deliveries from LUKoil, the price would be cut to $70 per ton. See: ‘LUKoil aims to be sole supplier to Neftochim after buy-in’, Platts Oilgram News, 23 September 1999. ‘Neftochim Mina Iztsialo na Petrol ot LUKoil’, Standard, 29 January 2000. ‘Ima li Taini Kadrovi Promeni v LUKoil’, Pari, 12 January 2005. ‘LUKoil Vlozhit do 2012 g. v NPZ LUKoil Neftochim Burgas $400m’, Kortes – Oil and Gas Spectator: Russian Market Patterns, 23 October 2004. ‘LUKoil shte Vlozhi 400m Dolara v Neftochim do 2012 g’, Dnevnik, 20 October 2004. Ibid. ‘LUKoil Tursi Strategicheski Partnior’, Kapital, 3 February 2001. ‘Korporativen Profil: LUKoil Neftochim – Burgas’, Dnevnik, 11 April 2005. ‘LUKoil – Neftochim e Nay-Golemiyat Danikoplatets za 2003 Godina’, Dnevnik, 23 February 2004. ‘Petrol i LUKoil – Otnovo Partniori’, Banker, 8 April 2005. Plamen Angelov, ‘Otvud Novinite – Dobroto Sustoianie na Petrol Razpalva Apetiti’, Pari, 5 February 1999. Galina Alexandrova, and Miglena Mancheva, ‘Prodazhbata na Petrol: Bal s Maski’, Kapital, 22 February 1999. E. Kazasova, ‘Yukos Oil Corporation ne Iska Imeto i da se Srvurzva s Yukos Petroleum Bulgaria’, BTA Biznes Novini, 28 June 1999. Galina Alexandrova, and Miglena Mancheva, ‘Prodazhbata na Petrol: Bal s Maski’, Kapital, 22 February 1999. This included mainly the deputy prime minister, Evgenii Bakurdzhiev, and the head of the budget committee at the Bulgarian parliament, Yordan Tsonev. See: Galina Alexandrova and Yovo Nikolov, ‘Chorni Stroi Imperia v Bulgaria’, Kapital, 8 March 1999. Ibid. ‘Borba za Bolgarskii Rynok Nefteproduktov Prodolzhaetsia’, Rossiiskaia Gazeta, 20 February 1999. Rosneft International held 50 per cent plus two shares in the consortium, while Petrol Holding Group and OMV held 37,5 per cent and 12.5 per cent respectively. See: Galina Alexandrova and Miglena Mancheva, ‘Kandidatite za Petrol Podkhvanakha Voina s Kompromati’, Kapital, 8 February 1999.

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88 Nadezhda Semerdzhieva, ‘LUKoil, Petrol i Rosneft International Podadokha Oferta za Petrol’, Pari, 15 February 1999. 89 Natalia Gotova, ‘Borba Mezhdu Gosudarstvom i LUKoilom Peremeshtaetsia na Mezhdunarodnuiu Arenu’, Kompania Delovoi Ezhenedelnik, 1 March 1999. 90 Galina Alexandrova, ‘Chorni Poiska i Bulgartabak Holding’, Kapital, 6 September 1999. 91 ‘Chizhov Lobira za Ruski Kupuvachi na Neftochim i Petrol’, Pari, 16 February 1999. 92 Nadezhda Semerdzhieva, ‘Privatizatsiiata na Petrol – Proba za Krachka kum Neftochim’, Pari, 18 February 1999. 93 Galina Alexandrova, and Miglena Mancheva, ‘Prodazhbata na Petrol: Bal s Maski’, Kapital, 22 February 1999. 94 Miglena Mancheva, ‘Yukos Petroleum Bulgaria Specheli Petrol za 52m Dolara’, Kapital, 15 March 1999. 95 Miglena Mancheva, ‘Sdelkata za Petrol Ostava Uravnenie s Mnogo Neizvestni’, Kapital, 12 April 1999. 96 Bletso Tsanev, ‘LUKoil Prouchva Usloviiata na Noviia Konkurs za Petrol’, Banker, 20 April 1999. 97 Miglena Mancheva, ‘Kandidatite za Petrol i Neftochim se Obedinikha sreshtu LUKoil’, Kapital, 26 April 1999. 98 Miglena Mancheva, ‘Mezhdunaroden Konsortsium Bulgaria Poluchi Razreshenie da Kupi Petrol’, Kapital, 5 July 1999.

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99 ‘Mezhdunaroden Konsortsium Bulgaria Plati 52m Dolara za Petrol’, Kapital, 9 August 1999. 100Beltso Tsanev, ‘Sudbata na Petrol a v Rutsete na Nikolai Pavlov’, Banker, 4 May 1999. 101‘LUKoil-Neftochim – Dali Naistina se Podobriava Otnoshenieto kum Minoritarnite Aktsioneri’, Dnevnik, 27 August 2004. 102The Naftex name was preserved for a subsidiary focusing on wholesale fuel trade: Naftex Petrol. 103Petrol AD auditor’s report and consolidated financial statements’, 30 September 2004 (www.petrol.bg). 104‘Firmen Profil – Petrol AD’, Pari, 4 October 2004. 105‘Povorot ot Bolgarskii Vorot’, Trud, 24 August 2000. 106Nadezhda Khirstova, ‘LUKoil Pregovaria za Pokupkata na Petrol’, Sega, 7 December 2004 (www.sega.bg). 107Personal communication with Kamelia Slaveikova, management adviser, external affairs, Shell Bulgaria. 108‘Nastuplenieto na Benzinostantsiite Produlzhava’, Banker, 30 December 2004. 109www.petrol.bg. 110Personal communication with Arzu Berk, press officer, external affairs Europe (Turkey, Bulgaria, Greece, Hungary, Romania), Shell Turkey. 111See: Law on Crude Oil and Oil Products adopted on 16 January 2003 (Zakon za Zadulzhitelnite Zapasi ot Neft i Neftoprodukti), www.parliament.bg.

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6. About the series: Russian foreign energy policy reports his series of reports establishes for the first time the confluence of Russian foreign policy with the acquisition of foreign energy assets by Russian entities. Nine specific country profiles focus on the oil, gas, electricity and nuclear power industries. Each report, written by an author of international standing, explains how Russian foreign energy downstream mergers and acquisitions are transpiring to consolidate the new Russian empire. These unique studies address many questions of substance for energy industry professionals, investors, policy experts, and decision makers who seek to make sense of the dynamic changes that have overcome the Russian energy complex and altered the balance of global energy geopolitics. Series Editor Kevin Rosner Ph.D., is a specialist in Russian oil and gas, security of critical energy infrastructure, and international energy-security policy. He is an external expert to the NATO and presently serves as the Director, NATO Forum on Energy Security. He is a Senior Fellow both at the UK Defence Academy and at the Institute for the Analysis of Global Security (IAGS) in Washington, DC. Posts held include Senior Security Advisor to the Baku-Tbilisi-Ceyhan pipeline company, Project Director with the Program on Cooperation with the Russian Federation at the OECD, and Project Manager with the UNESCO Science Division in Paris. Dr. Rosner is the founder of The Rosner Group serving leading members of the global oil and gas community with energy and security analytical products.

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‘Russian Involvement in Eastern Europe’s Petroleum Industry: The Case of Bulgaria’ Adnan Vatansever his report answers questions such as: as one of the largest foreign acquisitions by a Russian company occurred in Bulgaria, what lessons are applicable to charting future Russian downstream takeovers? Why have Eastern Europe and Western FSU countries been the primary focus of Russian acquisitions? What drives LUKoil (and other Russian oil companies) to pursue acquisition of assets in these regions? Finally, what is the stance of the Russian government in terms of promoting such acquisitions abroad? Adnan Vatansever is a freelance energy consultant and the author of a number of reports for Cambridge Energy Research Associates. He is currently in the process of completing his Ph.D. dissertation on Russia’s energy sector at the Paul Nitze School of Advanced International Studies, Johns Hopkins University. He holds a B.A. in International Relations from the Middle East Technical University in Ankara, M.A. in Russian and East European Studies from Georgetown University’s School of Foreign Service. Hardcopy ISBN 1-905050-40-2 E-report ISBN 1-90505080-1

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‘Kazakhstan: Energy Cooperation with Russia – Oil, Gas and Beyond’ Dr Ariel Cohen his important study explains how Russia, with its private sector and policy makers working in tandem, has exerted a significant amount of control over Kazakhstan’s vast natural resources and its economic freedom. It looks at the way Russia and Kazakhstan agreed to divide the Caspian Sea shelf and how Kazakhstan has managed to maintain good relations with Moscow overall, despite its insistence on exporting energy resources to China and Europe directly and its hopes to export through Iran. Ariel Cohen, L.L.B., Ph.D., is an international expert in international security/ terrorism; Russian, Eurasian, European and Middle Eastern foreign, security, economic and business policy. He is Senior Research Fellow in Russian and Eurasian Studies and International Energy Security at the Davis International Studies Institute at the Heritage Foundation. Dr. Cohen has conducted conferences and briefings for the US Government departments and agencies. He appears on major US and foreign TV networks. Dr. Cohen also has extensive experience consulting for the private sector, international organizations, and technical assistance projects in the Central and Eastern Europe and CIS regions. Hardcopy ISBN 1-905050-41-0 E-report ISBN 1-905050-81-X

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‘Georgia: Russian Foreign Energy Policy and Implications for Georgia’s Energy Security’ Liana Jervalidze his report shows that as Georgia has restructured its energy sector, the new Russian and Georgian political elites exerted their influence, particularly through the participation of Russian gas company Itera in privatizations of Georgian gas enterprises. And how, over the past few years, Russian-Georgian business groups with their offshore capital have been working to monopolise the Georgian economy and Russia’s gas industry has been consolidating its hold over the CIS pipeline infrastructure, particularly through the expansion of Gazprom. However, Gazprom failed to take control of Georgia’s pipeline infrastructure and Georgia is insistent on developing its pipeline potential in order to boost its role as a transit route to Europe, Turkey and Iran. Liana Jervalidze has worked with several government and research institutions working on Caspian region energy policy and development. She has advised private sector companies in on the development of east-west energy corridor and Georgia’s potential role in regional integration. Since 2003, Ms.Jervalidze has been working on the development of Georgia’s gas market. She has spoken on regional energy policy at international conferences in the CIS, Europe and the US. Her analyses have been published in both Georgian and English. Hardcopy ISBN 1-905050-35-6 E-report ISBN 1-905050-84-4

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‘Russia’s Energy Interests in Azerbaijan’ Fariz Ismailzade n 2003-2004, an increased number of senior Russian officials and major energy companies, such as Itera, Gazprom and RAO UES visited Baku in the hopes of participating in energy projects in Azerbaijan. While maintaining diplomatic relations with Moscow, Azerbaijan is more hesitant when it comes to close cooperation with Russian energy companies. Baku fears that if Russia gains more assets in Azerbaijan, control of these assets will be used for political purposes. This unique study looks at the confluence of Russian private and public sector interest Azerbaijan’s energy sector. Fariz Ismailzade works with the Inter-national Republican Institute in Baku and is a parttime lecturer at the department of political science at the Western University in Baku. He holds an MA in Social and Economic Development from Washington University, St. Louis, and a BA in Political Science from Western University, Baku. Hardcopy ISBN 1-905050-42-9 E-report ISBN 1-905050-87-9

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‘Ukraine: Post-revolution Energy Policy and Relations with Russia’ Olena Viter his report looks at how the new Ukrainian government plans to decrease Russian influence over Ukraine’s energy sector. President Viktor Yushchenko has declared goals which include the diversification of oil and gas supply sources, the reform of the domestic market, and the creation of a strategic oil stock. Ukraine’s search for more partners in the energy sphere has affected the relationship between Ukraine and Russia; from a "brotherly" relationship to one of pragmatic interest. Olena Viter is a Senior Adviser to the Operational Department of the Secretariat of the President of Ukraine. She is Coordin-ator of Energy Programs at the School of Policy Analysis, National University of Kyiv-Mohyla Academy, and a member of the non-governmental Expert Council on Energy Security. In 2002, she was an intern at the Hudson Institute, and in 2003 she participated in drafting Ukraine’s Energy Strategy. Hardcopy ISBN 1-905050-31-3 E-report ISBN 1-90505077-1

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‘Turkmenistan-Russian Energy Relations’ Gregory Gleason urkmenistan has large gas reserves, but as its immediate neighbours have little import demand, Russia holds the key to its gas transport. In April 2003 Turkmenistan and Russia concluded a 25 year transport and marketing agreement for Turkmen natural gas. The new arrangements permit Turkmenistan’s gas production to reach 100,000 million cm per year in 2007. This unique study details the background and looks at the prospects for Turkmenistan’s gas production and export in the context of Russian strategy, and at Turkmenistan’s role in the new energy strategies throughout Eurasia and the Middle East. Gregory Gleason, Ph.D., is an internationally recognized expert in energy policy and international relations. A professor of political science and public administration at the University of New Mexico, Dr. Gleason has extensive field experience in Turkmenistan and the other countries of Eurasia and Central Asia. He has served as a consultant to Lawrence Livermore National Laboratory, Sandia National Laboratories, the Asian Development Bank, and the US Agency for International Development. His research has been sponsored by the National Science Foundation and the National Academy of Sciences as well as other public and private foundations. Hardcopy ISBN 1-905050-33-X E-report ISBN 1-905050-82-8

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‘Belarus: Oil, Gas, Transit Pipelines and Russian Foreign Energy Policy’ Dr Margarita M Balmaceda elarus relies on Russia for about 85% of its total energy needs, while Russia needs Belarus’ oil and gas pipelines to export its supplies to Western Europe. How will energy exports from Russia and Belarus’ transit capabilities impact Western Europe if this interdependent relationship ends, either through political changes in Belarus or if Russia ends its energy subsidies to Belarus? This report looks at transit, infrastructure and investment issues and analyzes both the state of the current infrastructure, as well as the possibilities this transit opens to Western investors, particularly as the Yamal Pipeline nears completion. In addition, it looks at the current conflict between Belarus and Russian investors for control of the country’s gas transit system and oil refineries. Margarita M. Balmaceda is Associate Professor at the John C. Whitehead School of Diplomacy and International Relations, Seton Hall University, New Jersey, and an Associate of Harvard University’s Davis Center for Russian and Eurasian Studies and the Harvard Ukrainian Research Institute. She received a Ph.D. in Politics from Princeton University (1996), and Post-Doctoral training at Harvard University. She has published widely on Russian, post-Soviet and East European energy and foreign policies. Hardcopy ISBN 1-905050-34E-report ISBN 1-905050-83-6

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‘Gazprom and the Russian State’ Dr Kevin Rosner azprom is the world’s single largest producer of natural gas, long acknowledged as a state-within-a-state. In 2005 it reached a turning point in its history when the Russian government reasserted its majority stakeholder position, whilst also continuing its own push to gain control over an increasing share of Russia’s energy complex overall. This timely report provides answers to questions such as: what do these movements mean for the future of the Russian energy sector? What will be the impact of state control over Gazprom on domestic and foreign shareholders? And what do these changes portend for the future of natural gas exploitation, production, distribution and the ultimate export of Russian gas to downstream consumers? And what will these changes mean to world? Hardcopy ISBN 1-905050-30-5 E-report ISBN 1-905050-85-2

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‘Baltic Independence and Russian Foreign Energy Policy’ Dr Harold Elletson stonia, Lithuania and Latvia are uniquely dependent on the Russian Federation for energy supplies. The security of energy supplies are national security issues in the three ex-Soviet republics, which are now part of the EU. Increasingly dependent on Russian gas imports and with negligible sources of domestic energy supply, the Baltic countries have been the target of aggressive Russian commercial activity and a sustained attempt to lock them into a long-term reliance on Russia. Now, as Baltic political leaders, energy specialists and intelligence analysts consider their options, the implications for the security and independence of the three Baltic States are a matter of concern well beyond the Baltic. This important report will be essential reading for anyone with an interest in the future energy supplies of both the Baltic States and eastern Europe. Dr Harold Elletson leads The New Security Programme, which conducts research into the implications of the new security environment. He was previously Director of the NATO Forum on Business and Security. A former Member of the UK Parliament, he served as Parliamentary Private Secretary to the Secretary of State for Northern Ireland and as a member of the Select Committee on Environment. An international public affairs consultant and a fluent Russian speaker, he has advised many leading companies on aspects of their business in the former Soviet Union, including BP in Azerbaijan and Alstom in Siberia Hardcopy ISBN 1-905050-36-4 E-report ISBN 1-905050-89-5

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