OAO Siberian Oil Company (Sibneft)

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OAO Siberian Oil Company (Sibneft)

Sadovnicheskaya St. 4
113035 Moscow
Russia
Telephone: (+7) 95 777 3152
Fax: (+7) 95 777 3114
Web site: http://www.sibneft.ru

Public Company
Incorporated: 1995
Employees: 47,000
Sales: $3.57 billion (2001)
Stock Exchanges: OTC
Ticker Symbol: SBKUY
NAIC: 211111 Crude Petroleum and Natural Gas Extraction; 213112 Support Activities for Oil and Gas Field Operations; 324110 Petroleum Refineries

Moscow-based OAO Siberian Oil Company, known as Sibneft, is one of Russia’s top vertically integrated oil concerns. The company is active in exploration, production, refining, and wholesale marketing. Sibneft’s production activities are centered around the western Siberian city of Noyabrsk, where there are proven crude reserves of 4.6 billion barrels. The company’s refinery in the southern Siberian city of Omsk produces about 500,000 barrels a day and is the country’s number one producer of high-octane gas. Sibneft also holds a 36 percent stake in a refinery in Moscow. The company’s retail operations encompass more than 1,000 gas stations in western and central Siberia. Sibneft is closely held, with only about 12 percent of shares belonging to minority investors. Russian tycoon Boris Berezovsky has played a central, although never fully publicized, role in the company. More recently, Roman Abramovich has emerged as the figure in control of Sibneft. The company is nominally held, however, by several European banks, including ING Barings (23 percent), ABN AMRO (20 percent), and Deutsche Bank (17 percent). Eugene Shvidler has been president of Sibneft since 1998. Although the political entanglements and opaque dealings of Russia’s “oligarchs” have occasionally made investors uneasy about Sibneft, the company also has garnered attention for its moves to improve corporate governance. In particular, the company was the first in Russia to publish financial accounts according to U.S. generally accepted accounting principles.

Soviet-Era Development

The first oil discoveries in western Siberia came in the early 1960s. At that time, the Volga-Urals region, together with older developments in the Caspian and North Caucasus, accounted for the majority of Soviet oil production. Production in the Volga-Urals region began to drop, however, after 1975 as fields matured. The government hoped to offset this loss with production gains in western Siberia, and began pushing for more exploration there. In 1975 an engineering group was formed to explore the upper reaches of the Ob River. The group developed the Kholmogorskoye oilfield, the northernmost development at the time, and constructed the Kholmy pioneer settlement. The field began producing in 1976.

With production declines becoming more urgent, in 1981 the Soviet government adopted resolution 241, “On urgent steps to accelerate construction in the West Siberian oil and gas complex.” The resolution set out an ambitious oil production plan and directed the Kholmogorneft company to construct the settlement of Noyabrsk. On April 15, 1981, Noyabrskneftegas (“neft” is the Russian word for oil) was officially established. Housing and construction workers were brought in from far and wide to promote rapid development of the new complex. The Sutorminskoye, Muravlenkovskoye, and Vyngapurovskoye fields started producing in 1982. By 1985, a substantial industrial infrastructure had been built, and growth averaged about five million tons of crude a year.

The oil production methods applied at Noyabrsk, however, were unsustainable in the long run. Through the mid-1980s, the Soviet government had been pouring money into increased drilling in order to fend off declines in production. But most of the new developments, including those at Noyabrsk, were managed to maximize short-term recovery with little attention paid to prudent reservoir management practices. A decline in production was inevitable. After a 1988 peak, when the Soviet Union produced more crude than any other country, production began a decade-long fall to about half the peak level. Between 1991 and 1992 production fell 16.8 percent at Noyabrsk’s largest fields.

The Battle for Control: 1991–98

The Soviet Union was dissolved in 1991. Soon state-held enterprises were being transformed into private entities, as the powerful battled for control of Russia’s lucrative resources. The first privatizations came in 1992, when three vertically integrated oil companies were formed. Sibneft was created three years later in a second wave of privatization. On August 24, 1995, a presidential decree united the Noyabrskneftegas production association with the Omsk oil refinery to form the backbone of the new company. The Omsk refinery, constructed in 1955, was the largest and most up-to-date in the country, and had a history of processing oil from the Noyabrsk fields. Also rolled into Sibneft were the exploration unit Noyabrskneftegas-geophysica and the distributor Omsknefteproduct. The initial terms of the privatization process stipulated that the government was to retain control of 51 percent of the company for three years, and foreign ownership was limited to 15 percent. In January 1996, auctions turned over 49 percent of Sibneft to private investors.

The new company hired Miller and Lents, a Houston oil and gas consulting firm, to conduct independent audits of crude reserves at Noyabrsk. Audits were carried out annually from 1996 onward. The greatest challenge facing Sibneft was to stabilize production, which had been falling steadily through the early 1990s from 506 barrels per day in 1993 to 367 barrels per day in 1996. After 1996, yearly declines were smaller, but annual drops of 3 to 5 percent continued until the end of the decade.

Although Sibneft was supposed to remain under state control for three years, the cash-strapped government soon began looking for a loophole in that rule. Under the notorious “shares for loans” program, private investors provided loans to the government in exchange for the right to manage state holdings. Since the government never allocated funds to repay the loans, holdings in major enterprises were in effect transferred to business tycoons in a series of closed deals. In December 1995 the Finance Oil Corp. (FNK) gained control of Sibneft, then valued at about $600 million, in exchange for a $100 million loan. FNK was widely assumed to be controlled by business tycoon Boris Berezovsky, although Sibneft consistently denied any formal ties to Berezovsky. In May 1997 FNK officially gained control of Sibneft, managing to fend off a challenge from Oneximbank, owner of rival oil company Sidanco. Sibneft’s holdings were in jeopardy again that December when a government commission threatened to seize control of the Omsk refinery if Sibneft failed to pay a tax bill estimated at $88 million. On Christmas Day, however, Sibneft agreed to make a substantial payment, averting the asset seizure.

As the post-Soviet oil industry matured, it began looking abroad for capital support. In late summer 1997 Sibneft became the first Russian company to issue a Eurobond. The $150 million bond was the first in a series of Russian corporate debt issues. Later that year industry consolidation became a hot topic. In January 1998 Sibneft signed a letter of intent to merge with Yukos, another large West Siberian oil company controlled by financier Mikhail Khodorkovsky. Prime Minister Viktor Chernomyrdin was present as the signing ceremony, expressing the government’s desire to see the country’s approximately 16 firms consolidated into four or five. The merged company, to be known as Yuksi, would be the largest private sector oil company in the world in terms of reserves. The merger would certainly bring benefits related to efficiency, as Sibneft’s surplus refining capacity would balance out Yukos’s excess crude extraction. Nevertheless, minority shareholders worried that the merger had more to do with accumulating political clout than with improved management. As the business press marvelled at the potential clout of such a giant oil concern, falling crude prices and disagreements over strategy cast doubt on the deal. Merger plans were conclusively abandoned in May 1998.

Company Perspectives

Our mission is to learn how to manage oil assets as profitably and efficiently as the world’s leading oil companies, and then to apply these skills to the task of maximizing returns in the Russian environment.

We aim to introduce global best practice across the whole range of our operations, from the way we manage our wells to the way we manage our people.

Sibneft’s mission statement embraces five key goals: To focus on long-term profitable growth. To fully realize and enhance the potential of our resource base, our people and the markets we serve. To provide a world class return on a high quality asset base. To create a simple and transparent corporate structure. To set a new Russian benchmark for efficiency and competitiveness in the oil industry.

Sibneft has come a long way in five years, and has already made substantial progress towards achieving each of these key objectives. By introducing modern systems for financial control and budgeting, we have improved the quality of our decision making. By cutting costs and raising productivity, we have laid the foundations for long-term sustainable growth.

Sibneft still has a long way to go to completely shed the legacy of our Soviet past. But we are firmly committed to building and investing in a modern thriving business which generates superior returns and brings benefits for all our stakeholders.

Low crude prices continued to put a squeeze on Russian oil, and industry leaders asked for tax breaks from the government. Oil company taxes, however, were by far the government’s largest source of revenue. The drop in revenues associated with low oil profits led to the August 1998 financial crisis, when the ruble was severely devalued and the government defaulted on its loans. Sibneft weathered the crisis more easily than some, managing to meet all of its loan obligations. One casualty of the crisis was a deal with Elf Aquitaine SA, in which the French company called off plans to pay $528 million for a 5 percent stake in Yuksi/Sibneft. Sibneft went looking for an alternative partner to develop its Sugmut field, which had reserves estimated at 672 million barrels.

Advances in Efficiency and Transparency: 1998–2000

In the wake of the failed merger and the financial crisis, Sibneft began to focus on improving its own efficiency and transparency. In July 1998 the company had published a corporate governance charter, which provided for adding non-executives to the board. In September of that year Sibneft moved to consolidate its various units into a single share. Newly issued shares in the parent company were exchanged for equity held by outside investors in Sibneft’s subsidiaries. A new contract with Schlumberger, the U.S. oil services firm, also boded well for the future. In a pilot project, Schlumberger had significantly improved flow rates at 150 wells by applying hydro-fracturing techniques. Sibneft also was moving ahead with exploration despite low oil prices, having brought 209 new wells into production in 1998.

A new president, Eugene Shvidler, took the helm at Sibneft that year, moving up from his former position as chief financial officer. With more experience in the industry than many of the businessmen at the head of Sibneft, Shvidler had the potential to improve on the company’s mixed results and falling production. Things got off to a rough start in 1999, when commandos raided Sibneft’s Moscow headquarters and federal investigators seized equipment allegedly used to eavesdrop on President Boris Yeltsin. Observers speculated that the raid was ordered by Prime Minister Yevgeni Primakov, who hoped to improve his chances at winning the presidency by targeting the company supposedly controlled by Yeltsin’s friend Berezovsky.

Developments later in the year, however, showed more promise. Sibneft launched a level one ADR (American Depositary Receipt) program in April, allowing its shares to be sold over the counter in Frankfurt, Berlin, and the United States. That spring an issue of 300 million new shares facilitated the consolidation of the Noyabrskneftegas production subsidiary into its parent company. The maneuver increased Sibneft’s free float in 1999 from less than 3 percent to 12 percent. In the fall Sibneft solidified its connection with Schlumberger in an alliance that would allow the oilfield services firm to make broad improvements on oil and gas extraction without having to negotiate specific contracts. In addition, Sibneft drew on the expertise of other services firms, such as BJ Services of Canada. The firm also broke ground in 1999 by hiring accounting firm Arthur Andersen to publish its accounts according to U.S. generally accepted accounting principles. The accounts showed a profit of $315.1 million on revenues of $1.74 billion in 1999. Although revenues were down slightly from the previous year, net income was up nearly nine times due in part to a fall in production costs related to the devalued ruble. Some observers, however, put a more negative spin on the year, noting that the company spent a modest $59 million on capital investment, and crude production had reached an all-time low of 322 barrels per day.

Late in 1999 Roman Abramovich, a 33-year-old close friend of the Yeltsin family, emerged as an executive and major shareholder at Sibneft. In a well publicized visit to Noyabrsk, he said he controlled about 40 percent of the company and announced plans to run for the governorship of Chukotka province in the Russian Far East. In a New York Times article, Michael Wines wrote that Russia’s oil companies seemed to be leaving their “murky” past behind them: “Russia’s oil tycoons largely founded their empires through dark-of-night political deals and squeezing out competitors, and until lately they have run their companies pretty much the same way. But now, if the barons themselves are to be believed, the era of wildcatter capitalism is over.” Wines noted that Sibneft had recently touted itself as “Russia’s most progressive company” in a local newspaper, a statement backed up by its publishing of GAAP-audited accounts and a corporate governance charter. Management also was improving under Shvidler. The company was close to paying off three quarters of its debt and planned to open 1,000 retail gas stations in Siberia.

Nevertheless, concerns lingered about possible conflicts of interest in the relations between Sibneft and its subsidiaries and customers. The true ownership of the company also remained unclear. Almost 90 percent of the company was controlled by an insider group, but the actual holdings of individuals could not be verified. The potentially destabilizing political ties of the company’s management were another worry. Such pessimistic views seemed corroborated when, in August 2000, Sibneft’s Moscow headquarters were raided by the tax police. Russia’s new president, Vladimir Putin, had been taking a hard line with many Yeltsin-era “oligarchs,” but had been criticized for favoring Abramovich, who had close ties to the Yeltsin-Putin circle. Soon, however, Sibneft was singled out and accused of paying lower taxes than any of the competitors. Sibneft claimed the government’s figures were inaccurate and cooperated in supplying the tax police with documents. Much of this political maneuvering was related to the battle to gain control of newly privatized oil concerns. Sibneft was bidding in partnership with Yukos for the Onaco oil company. The two companies lost the bid to Tyumen Oil Co., but Sibneft did manage to gain control of 40 percent of Orenburgneft, Onaco’s main producing subsidiary.

Key Dates

1955:: A refinery is opened in Omsk.
1975:: An engineering group begins drilling on the upper Ob River.
1981:: Noyabrskneftegas, an oil production association, is officially established.
1988:: Soviet oil production peaks and begins to decline.
1995:: A presidential decree forms Sibneft, uniting Noyabrskneftegas and the Omsk refinery.
1997:: Boris Berezovsky’s Finance Oil Corp. gains control of Sibneft.
1998:: A planned merger with Yukos is called off amid falling oil prices.
1999:: Roman Abramovich emerges as a major stakeholder in Sibneft.
2000:: Crude production at Sibneft rises for the first time.

Rising Revenues and Increased Investment: 2000-02

In spite of a few negative incidents, the year 2000 as a whole marked a turnaround. Sibneft saw its first rise in crude production—a 5 percent gain to 338 barrels per day—since the founding of the company. Net revenues for the year soared to $2.4 billion, and net profit more than doubled to $674.8 million as the oil industry revelled in high crude prices. Sibneft also brought four new fields into production in 2000, bought two refined products retailers in the Urals region, and invested over $50 million in an upgrade of the Omsk refinery. In November the company entered into a joint venture with Yugraneft, the Russian subsidiary of U.K.-based Sibir Energy. The partnership would work on developing sections of the Priobskoye field and the Palyanovskoye deposit, where reserves were estimated at about 2.1 billion barrels. With a rosy financial outlook, Sibneft was able to pour money into several more development projects. The company planned to triple capital investment in 2001 to $595 million, with $120 million targeted at the one-billion-barrel Sugmut deposit.

In 2001 Sibneft burnished its reputation for corporate governance. The company won a $175 million syndicated loan from Western banks that spring, a sign of rising confidence on the part of Western financiers. Then in August Sibneft announced that it would pay an unprecedented dividend of $612 million, a move that gained the company even more credibility in the eyes of shareholders. More cynical observers, on the other hand, speculated that there was likely to be an ulterior motive to the large payout. Sibneft’s reputation did in fact suffer a blow when the details were revealed about a certain deal in December 2000. The Russia Journal reported that Sibneft had bought a 27 percent stake from core shareholders, including Abramovich, then sold the shares back just before the dividend payout. The deal apparently functioned as an interest-free loan to company insiders, and minority shareholders protested that they should have had a chance to buy some of the 27 percent stake. Sibneft responded that there was no requirement that shares be offered for wider sale, asserting that the transactions were merely a matter of dealing with extra cash on the one hand and a need for debt reduction later.

Net revenue rose again in 2001 to $3.57 billion and profits reached $1.3 billion. Sibneft acquired 36 percent of a refinery in Moscow that year and, in a joint venture with Yukos, began exploring for oil in the Chukotka autonomous district, where Abramovich had recently been elected governor. Company President Eugene Shvidler told Sabrina Tavernise of the New York Times that the oil industry was focusing more and more on good management rather than battles for control. “The industry has consolidated and gotten a lot smarter,” he said. “Owners are leaving management roles, and professionals are taking their place. Owners are people who like to do deals. But after that, you need to just sit and make money. That’s a totally different type of work—more boring.”

For the time being, however, the “boring” details of management continued to vie with ownership maneuvers as Sibneft entered 2002. The company opened its first gas station in Moscow early that year and planned a $61 million program to expand its retail operations with 200 more outlets. At the same time, oil companies were vying for control of the state-owned Slavneft, which was scheduled to be partially privatized in October. Sibneft’s continuing ties to inside Kremlin circles gave the company an edge. Former Sibneft executive Yuri Sukhanov was appointed president of Slavneft in May, putting Sibneft in a good position to acquire the 20 percent stake that was expected to be auctioned.

Principal Subsidiaries

OAO Moscow Oil Refinery (36%); OAO Omsknefteproduct (94%); OAO Sibneft-Noyabrskneftegas (97%); OAO Sibneft-Noyabrskneftegasgeophysica (81%); OAO Sibneft-Omsk Oil Refinery (87%).