Fifteen years after the first oil joint ventures were set up in the former Soviet Union, smaller oil companies and JVs are still struggling.

"From this moment on, Russia has become a full-fledged player on the world market, and this will set off a flow of investment, first of all into the oil and gas sector, which, like a locomotive, will draw everything else along after it."

This was a statement made by Mikhail Fridman when he announced that he was selling his and Viktor Vekselberg’s shares in Tyuman Oil Co. (TNK) to British Petroleum (BP Amoco) for $6.75 billion.

The merger of TNK, Sidanco and other Russian assets of Fridman and his partners with BP will put the resulting company in the Top Three companies on the Russian oil market. But a closer examination reveals that Fridman might have been carried away a bit in the heat of the moment.

First of all, the $6.75 billion that BP has promised to pay its Russian partners is not really an investment into the company – it’s a pay-off for taking over assets that the Russian side controlled, having wrested them from state ownership.

Second, a large part of the money will be paid from the companies’ own cash flow.

And third, little of what is being invested is ever likely to be invested in Russian oil, if it ever makes its way to Russia at all – most Russian owners have their shares registered in the name of offshore entities, and they are the ones that will get paid.

According to the State Statistics Committee, the entire Russian energy sector received just over $2 billion in foreign investment in 2002. Most of it might have been from offshore accounts of Russian owners.

Joint venturePartnersOil production in 2002 (in thousands of tons) BashmineralBashneft – 51 percent, group of Hungarian companies – 49 percent59.8 VanyoganneftOccidental Petroleum (U.S.)and TNK – Nizhnevartovsk each with 50 percent2.753 Geoilbent LimitedHarvest Natural Resources (U.S.) – 34 percent and Itera – 66 percent891.2 GoloilGoltech Petroleum LLC (U.S.) 70,59 percent, and a group of Russian companies with 29.41 percent251.1 ZMBYukos and MOL (Hungary) Tatnefteprom, Tatneft, Tatneftekhiminvest-Holding, 50 percent each36.1* IdeloilAminex PLC (Ireland) – 29.7 percent, Zarubezhneft – 70.3 percent92.5 TATEXTatneft and Seagull Energy (U.S.) – 50 percent each457.2 PetrosakhNimir Petroleum Ltd. (Saudi Arabia) – 95 percent and Sakhalin Oil Company – 5 percent201.7 Polyarnoye SiyaniyeConoco (U.S.) – 50 percent, Rosneft – 20 percent, Arkhangelskgeoldobycha 30 percent1,183.8 Severnaya Neft**Euroluxe Holdings Group Ltd. and Transatlantic Ltd. – 20 percent each, Cadmen Ltd., Dellmark Holdings Corp. – 15 percent each, TBKOM AG – 10 percent, Komineft – 5 percent1,474.1 TarkosaleneftegazTNG Energy (Germany) — 50.1 percent,Itera – 11.5 percent, Novafininvest – 20.3 percent, Purneftegazgeologiya – 9.1 percent, Surgutgazprom – 3.9 percent, Noyabrskgazdobycha – 3.9 percent444.4 TatoilgazTatneft – 53 percent, Mineral Rohstoff Handel (Germany) – 47 percent278.1 ChernogorskoyeAndermdam Smith Overseas (U.S.) – 50 percent, TNK-Nizhnevartovsk – 50 percent435.2 Uralskaya NeftUdmurtneft and Invest Leasing (Czech Republic) – 50 percent each.143  TOTAL:8,701.2*** * Output for December. ZMB was founded on Dec. 19, 2002
** Rosneft has already announced the purchase of 100 percent of the shares in Severnaya Neft, but the deal is not completed yet.
*** Share of overall Russian oil production: 2,29 percent
Source: Fuel and Energy Sector Central Dispatching Department of the Energy Ministry) BP’s is not the first major oil deal in Russia. There have been many joint ventures formed over the last decade in Russia, and large hopes placed on them –and, unfortunately, almost all have failed to live up to expectations. Only time will tell whether BP made a wise decision.

The first joint ventures appeared in 1989, when the Soviet regime was still in place. Joint ventures sprung up in increasing numbers with the splinters of the previously unified Soviet-era Oil and Gas Industry Ministry following the collapse of the Soviet Union. The new owners of oil and gas assets would reach agreements with foreign partners to develop some small deposit somewhere, transferring their assets to the new venture, while the foreigners would contribute their share in cash.

The foreign partners would also contribute modern production and management technology, making it possible to develop small and hard-to-access deposits. More importantly, they paved the way for large companies, convincing big oil that it was possible to work and make a profit in Russia.

By the mid-’90s, there were 42 joint ventures in oil extraction and more than 20 in maintenance and repairs of other companies’ oil wells. The extraction joint ventures had more than 200 licenses to explore and develop deposits, and their production output was increasing all the time. By 1997, joint ventures were pumping out 18.5 million tons of oil – up 19.9 percent on the previous year. Joint ventures at that time accounted for 6.2 percent of total oil output in Russia. Investment in the Russian energy sector was also increasing, and, thanks to the joint ventures’ success, topped $1.5 billion for the first time in 1997.

But, in 1998, joint ventures began to face tough times. First, the collapse of world oil prices, beginning at the end of 1997 and lasting throughout 1998, saw small oil companies’ revenues fall. The slump in demand abroad led to overproduction in Russia, and the success of the small oil companies began to get in the way of the large vertically integrated oil companies.

These companies took advantage of the fact that their smaller counterparts did not have oil refineries of their own and began refusing to take their oil, or else offered such a low price that it did not even cover production costs.

"The small and medium-sized oil companies began to have problems with sales, and it became difficult for them to sell their oil because there were fewer and fewer independent oil refineries," said Dmitry Tsaregorodtsev, an analyst at Prospekt-Investment. "Nizhny Novgorod’s Norsi-Oil, which was independent, came under the control of LUKoil like this. Moscow Oil Refinery is in a strange situation, and it’s not clear whose oil they’re taking there. Basically, the only independent refineries left belong to the Alliance Group. Then there are the refineries in Bashkortostan. But the Alliance Group’s refineries are far away in Khabarovsk and in Kherson in Ukraine, while the Bashkortostan refineries prefer to work on a tolling system."

Difficulties with sales and refining coupled with a rising tax burden after the 1998 financial crisis, led to falling interest in oil joint ventures. The big [Russian] oil companies bought up the shares of departing foreigners and consolidated them in their own local interests.

LUKoil was the most aggressive among those acquiring foreign shareholder’s interests. In 1999, it absorbed the KomiTEK oil company and took control of the Komi Republic’s largest oil joint ventures: Nobel Oil, KomiArcticOil, Bitran, Parma-Neft, Permtex, Baitek and Amkomi. One of the most recent examples of foreign investors pulling out of the oil business in Russia was when the Croatian company Ina sold 100 percent of its shares in the Beliye Nochy joint venture to a Rosneft subsidiary company in August 2002.

Not all the oil takeovers were civilized. TNK (the same one that BP took over recently,) for example, simply kicked Canadian company Black Sea Energy out of the Tura Petroleum joint venture that had been set up in 1996. Black Sea Energy had owned half the shares. In 1998, TNK had protested licenses to develop the Kalchinsky and the Severo-Kalchinsky deposits that were given to Tura Petroleum. It then bankrupted the joint venture and bought up all its assets for less than $10 million.

Ivanhoe Inc., the successor company to Black Sea Energy, tried to get compensation for its losses – which, with lost profits factored in, were valued at $100 million – at the International Arbitration Court in Stockholm, but it was forced to give up in August 2000, agreeing to part with its business in Russia for $29.22 million.

Another company, Norex Petroleum, met the same fate when TNK forced it out of the Yugraneft joint venture. Yugraneft was set up in 1991 by Canadian company NowscoR and Russian company Chernogorneft to develop the Malochernogorsk deposit. The Canadians initially held 60 percent of the shares, and, by June 1999, their share had increased to 97.64 percent.

With almost all the shares in their hands, it would have seemed the Canadians should have nothing to fear, but things turned out differently. TNK took control of the Chernogorneft and then insisted on bringing its share in the joint venture back up to the initial 40 percent. TNK then succeeded in obtaining an arbitration decision in a regional court in a questionable ruling that the know-how the Canadians had contributed to the venture in 1991 was worthless. As a result, the Canadians saw their share in the venture decreased to 20 percent, and then they were forced out altogether.

This conflict is still going on today, and Norex Petroleum has called the sensational deal with BP "the sale of stolen goods."

The only successful example of a joint venture fighting back against a big oil company was the case of Severnaya Neft. But the reason this company was successful was that the real owners of Swiss company TBKOM AG, which helped found Severnaya Neft, were Russians with deep tentacles into the government and who knew how to fight and survive the Russian way.

In 1999, LUKoil, which through Komineft owned a 25 percent stake in the company’s charter capital, tried to take control of Severnaya Neft by buying up another 35 percent of shares from two partners. Some heavy weigts such as former Deputy Finance Minister Andrei Vavilov then stepped in to fight on behalf of Severneft.

In Dec. 1999, an extraordinary shareholders’ meeting decided on a new share issue, and Severnaya Neft’s charter capital was increased tenfold. The newly issued shares were distributed through closed subscription among six off-shore companies controlled by Vavilov, and Komineft saw its share in the joint venture go down to 2.5 percent. A little later, an attempt was made to push Komineft out altogether by forcing out shareholders with a less than 5 percent stake, offering them compensation in return. But Komineft managed to hold its place.

Since then, LUKoil has attempted repeatedly to restore the status quo, eventually forcing the owners of Severnaya Neft to look for protection from another big oil company. Severnaya Neft was sold to Rosneft at the beginning of 2003 for $600 million.

The history of small joint ventures in the Russian oil sector seems to be mostly over. The only area they could still probably work in is in developing unpromising deposits unlikely to interest serious competitors.

"Throughout the world, small companies are involved mostly in developing deposits with few resources, and Russian companies will go the same way," said Prospekt Investment’s Tsaregorodtsev. "Serious investment is needed to develop big deposits. Most of the joint ventures were set up by financial investors and now, they’re pulling out of the companies they set up. I think they’re doing so with a profit in most cases. The same is true for Russian companies – joint ventures and Russian companies of a similar size are facing the same difficulties."

The joint ventures that manage to get financial support from serious investors, above all from the big oil companies, have the best chance of survival. The joint ventures operating in Tatarstan, for example, feel secure under the double protection of local oil company Tatneft and the regional authorities. Nothing threatens the Polyarnoye Siyaniye Company as long as LUKoil is counting on Conoco, which helped found the venture, to work with it on its Northern Territories project.

Another company with nothing to fear is ZMB, set up in December 2002 by Yukos and Hungary’s MOL. This joint project to develop the Zapadnoalobalyksky deposit, which has reserves of 23 million tons, is not an aim in itself for Yukos. Rather, the cooperation with MOL provides a guarantee that Yukos, which currently covers 75 percent of Hungary’s total oil imports, will keep its hold on the Hungarian market.

Erkin Nusurov, an analyst at Nikoil, said that conditions are being laid now for joint ventures in Russia to move to a new level. The small joint ventures will gradually disappear, while larger companies founded by Russian and foreign partners will take their place.

"The BP deal is, of course, a mega deal, and there’s unlikely to be a repeat in the near future," Nusurov said. "But it is likely to set the direction for the future development of the Russian oil and gas sector with consortiums of Russian and foreign companies developing Russian deposits. One example of this could be the development of the Vankorskoye field, where they’re expecting the arrival of TotalFinaElf."

As for the fate of the joint venture set up by BP and AAP, it is not clear yet what the results will be. The large companies of today might be reduced to small, unprotected players of tomorrow.

The largest joint ventures still independent from the big oil companies and the results of their activities for 2002.