ConocoPhillips buying stake in Lukoil

September 29, 2004

HOUSTON, Sept. 29 -- ConocoPhillips will buy 7.59% of OAO Lukoil for $1.99 billion and join the Russian company in a strategic alliance outlining how it might increase the interest to 20%.

The two majors Wednesday announced the creation of a joint venture to develop fields in northern Russia's Timan-Pechora oil and gas province and also an intention to jointly seek the right to develop giant West Qurna oil field in Iraq.

"This investment is consistent with our exploration and production strategy of increasing reserves and production growth in new legacy areas at attractive costs," said ConocoPhillips Pres. and CEO Jim Mulva.

Lukoil Pres. Vagit Alekperov said, "ConocoPhillips's investment. . .shows the confidence that ConocoPhillips' management places in the continuing growth of investment attractiveness of Russia and the Russian energy industry, and opens new opportunities for high-quality growth of Lukoil."

The transaction furthers bilateral energy development between the US and Russia, including the potential supply of Russian oil and natural gas to US markets, the companies said in a joint news release.

Rick Burdick, an Akin Gump Strauss & Feld LLP attorney based in Washington, DC, represented Lukoil in the negotiations, which he said took more than 18 months. Lukoil approached ConocoPhillips, he said, noting the Russian government endorsed the deal.

"This transaction reflects the internationalization of the Russian oil business. I think it also reflects the favorable dynamics of the US and Russian policy right now, tilting the US toward Russia as a preferred supplier. This, combined with the TNK-BP deal, represents a departure from the historical approach to Russia by Western oil companies. Whether that will continue or not, you have to do a company-by-company analysis and see if the dynamics are there to put together a transaction," Burdick said.

With partners Alfa Group and Access-Renova (AAR) of Russia, BP PLC formed TNK-BP, a company owned and managed 50:50 by BP and AAR (OGJ, Feb. 17, 2003, p. 34). In addition, BP and AAR agreed to incorporate AAR's 50% interest in OAO Slavneft into TNK-BP (OGJ, Sept. 8, 2003, p. 36). Between those two transactions, BP has invested about $8 billion in Russia.

Equity transaction
ConocoPhillips successfully bid for 7.59% of Lukoil in a Russian government auction. The purchase price works out to $30.76/share, and the transactions remains subject to US Federal Trade Commission approval.

In addition, ConocoPhillips said it intends to initiate a tender offer outside the US for up to 2.4% more of Lukoil's equity capital on the open market at a price of up to $30.76/share. That tender offer also remains subject to FTC clearance.

A shareholder agreement between the two majors will govern ConocoPhillips's equity investment in Lukoil. Terms call for ConocoPhillips's ownership in Lukoil to be limited to 20% and also restricts ConocoPhillips's ability to sell Lukoil shares for 4 years.

Lukoil and ConocoPhillips plan to commence a comprehensive management exchange in corporate and operating areas, beginning in 2005. ConocoPhillips initially will have one director on the Lukoil board. Its board representation will be proportional to the number of shares that it acquires in Lukoil.

Upstream partnership
The two companies also are announcing a joint venture with Lukoil holding 70% and ConocoPhillips holding 30% for a partnership to develop Lukoil's reserves in the northern Timan-Pechora area.

ConocoPhillips will pay more than $370 million for its interest in the venture's oil and gas properties, together with an additional payment for its 30% share of working capital and its 30% share of Lukoil's capital investments in the venture's fields. The precise amount of the acquisition price will be established at closing.

The joint venture, to be governed 50:50 by Lukoil and ConocoPhillips, is expected to produce and market 200,000 b/d of oil by 2008. Production will be transported via pipeline to a terminal at Varandey Bay on the Barents Sea.

Lukoil will expand the terminal's capacity to 240,000 b/d by 2007 with ConocoPhillips participating in the design and financing the expansion.

Partnership in Iraq
Lukoil and ConocoPhillips will cooperate with the Iraqi government to confirm the validity of Lukoil's rights under its production-sharing agreement for West Qurna field in Iraq.

Subject to obtaining all required consents of governmental authorities and the parties to the contract, Lukoil and ConocoPhillips expect to enter into further agreements regarding the assignment by Lukoil to ConocoPhillips of a 17.5% interest in the PSA.

Reaction
Doug Stinemetz, a partner with Haynes & Boone LLP in Houston, said the Lukoil-ConocoPhillips transaction and joint venture will increase interest in Russia.

International oil companies are looking for large oil fields with which they can increase reserves, and Russia and Iraq are two places holding large oil potential, he noted.

"For the industry as a whole, I see it as another vote of confidence in the Russian market, and this means that the door is open for business in Russia," Stinemetz said. Although he was not involved in the Lukoil-ConocoPhillips agreements, he currently is negotiating proposed transactions in Russia on behalf of international oil companies and oil service companies.

The deal should help relieve any fears that the energy industry might have about investing in Russia given legal and financial difficulties for OAO Yukos, Stinemetz said. The problems between Yukos and the Russian government represent a unique situation, he said (OGJ, Sept. 6, 2004, p. 32).

"A lot of people had been worried that, somehow, the attack on Yukos signaled a general effort to renationalize the Russian oil industry and that after Yukos the other oil companies would be next," Stinemetz said.

The Lukoil-ConocoPhillips announcement disproves that theory, he said.

"If the Russian government was interested in renationalizing the Russian oil industry, it would not be selling its sole remaining stake in Lukoil to ConocoPhillips. It would not be permitting any of this to happen," Stinemetz said.

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