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Lukoil mulls Treasury shares sale option

Russia's largest privately-owned oil producer hopes its new long-term strategy will help maintain its status as a market favourite

Lukoil remains a sweetheart among investors, due to its western-style management and its progressive dividend policy—it is regarded as the "consensus-long" bet amongst Russian stocks. But investors are keen to see fresh drivers for the company's growth and believe disposal of its treasury shares could be one promising avenue.

The Treasury shares—issued ones that the firm holds itself—represent around 16% of the company's total equity and currently reside offshore in Cyprus. One option is to sell them on the stock market and raise funds for the implementation of large-scale projects, while a second option would be to distribute them among shareholders.

"Despite positive governance changes at Lukoil over the last 1.5 years, the market is still sceptical on its promises," says Ilkin Karimli, senior energy analyst at Credit Suisse. "The management needs to continue the course and cancellation of treasury shares would be a strong step to address legacy corporate governance concerns."

Lukoil has responded to Russia's production cuts in tandem with Opec by reducing output at its least-profitable and highest-taxed fields. Debt is being paid down, while $1.45bn was raised in May by the sale of its diamond business to lender Otkritie.

With the company preparing for its investor day in March, the investment community is scouring its new three-year and 10-year development plans for fresh clues on its direction.

According to its new 10-year strategy, output will be increased in the medium-term via the development of North Caspian greenfields, a lower rate of decline than at traditional West Siberian fields and progressing gas projects in Uzbekistan.

The company has started a drilling programme in Western Siberia at the Pyakyakhinskoe oilfield and Filanovskoe fields in the Caspian, part of an effort to slow oil-output decline rates in the reg-ion from 7% now to 2%. Western Siberia remains the company's main oil production region, representing 42% of all output and 54% of its proven oil reserves.

Leonid Fedun, vice president at Lukoil and a major shareholder with a 10% stake, believes the Opec deal will survive, at least in the short term. "My personal opinion is that the deal with Opec will be prolonged and in general, I assume that this deal can become, if not eternal, then long-term beyond 2018," he told a Moscow conference in September.

Lukoil, created shortly after the Soviet Union's collapse, plans to keep pumping 100m tonnes (790m barrels) of oil a year between 2018 and 2027 with projects outside Russia, including potential investments in Iranian oilfields, likely to help keep annual investment at $8-8.5bn.

16% - Share of total equity in treasury sales

Lukoil insists its massive investment to reverse a decline in output is starting to pay off, allowing it to compensate for weaker prices with higher volume. Capital expenditure over the next 10 years will amount to $80-85bn.

However, recent production increases came to a halt in September when output slid by 0.4%.

Fedun told Reuters in a recent interview that Lukoil would produce around 117m tonnes of fuel this year, 121m tonnes in 2018 and 123m tonnes in 2019.

Under its new strategy, Lukoil plans to add 1.1bn-1.2bn tonnes of hydrocarbons to reserves, while its gas output is seen reaching 35bn-40bn cubic metres a year by 2027.

The company, which has suffered from lacklustre output from its Western Siberia fields, has maintained production levels by concentrating on growing in new regions, such as the Caspian Sea and Iraq. It is also looking at Iran and Mexico.

The 2018-20 budget would be based on an oil price of $50 a barrel and a rouble rate of 62-64 roubles to the dollar, according to Lukoil's chief executive Vagit Alekperov.

In Uzbekistan, the company is planning to invest $3bn in gas projects by 2021-22.

Lukoil has been in talks with the National Iranian Oil Company on taking part in the development of Ab-Teymour and Mansouri fields in central-western Iran.

"We are very close, we have some disagreements that are not crucial, regarding output volumes and the pace of coming to any given levels," Alekperov said when announcing the company's 2018-27 strategy in September. He added that he was confident the differences could be resolved.

Growth strategy

In neighbouring Iraq, Lukoil's output at its giant West Qurna-2 field has reached 400,000 barrels per day. The next step is to expand the necessary infrastructure and increase production to 0.5m-0.6m b/d.

The initial plan was to reach the production plateau of 1.6m b/d, but the Iraqi government had to slash the target as part of the global efforts to curb production to support weak oil prices.

Lukoil's new project in Iraq, known as Block 10, is another highly promising asset that the company says could potentially contain "hundreds of millions of tonnes" of oil.

Lukoil has been steadily growing its gas output and is now seeking to sell natural gas from its Khvanlynskoye deposit on Russia's border with Kazakhstan to China. The deposit has proven reserves of 332bn cm of gas and 36bn tonnes of oil. Under development plans, 8bn cm of natural gas is forecast to be produced annually.

When Lukoil first started developing the deposit back in 2003, the idea of exporting gas to China was already on the table. But the prospect was thwarted by the Kremlin, providing Gazprom with a monopoly on exporting natural gas.

That law was partially liberalised in 2013, allowing other companies to also export liquefied natural gas. Now, Lukoil and the other natural gas independents like Novatek and Rosneft, are lobbying intensively for full access to the export pipelines. Currently, Lukoil is understood to be looking at possible routes of delivering gas to China and is supposed to choose between Russian and Kazakh pipelines. Lukoil's investment strategy remains centred on its dividend policy, as it is the only company among its domestic peers to employ a progressive dividend strategy.

Management has said 120 roubles per share should be paid in dividends this year, translating into a yield of 7%. However, some doubt whether the company can maintain its sector-leading payouts.

"The market remains sceptical around the management's commitment to the dividend policy and virtually every year, it is about de-risking market expectations," says Credit Suisse's Karimli.

He says Lukoil could continue increasing its dividend per share by 10% a year through to 2020 and still be able to cover the cost organically through its cash flows. One highlight of the company's second quarter results was a strong free cashflow position of $1.4bn.

Lukoil is currently mulling an initial public offering of Litasco, its trading arm in Europe, or merging Litasco with another major trader, such as Trafigura, Gunvor or Glencore.

The company's board is expected to discuss the sale of Litasco at some point before the end of 2017. Litasco is responsible for all the international trading and marketing of Lukoil's crude oil and refined products.

Analysts have speculated that one potential reason behind the sale is the new US sanctions on Russia, which could complicate the process of raising funds for Litasco.

Alekperov, who is Lukoil's largest shareholder with about a quarter of the total, believes Western sanctions against Russia will be in place for the next decade.

"The market is still sceptical on Lukoil's promises" - Ilkin Karimli

"I don't perceive that sanctions will be removed in the coming years, and even [when they are] it will be a lengthy and very complicated process," Alekperov told the Financial Times in October.

Lukoil, along with Rosneft and a host of major Russian energy and finance companies, were sanctioned over the Kremlin's interference in the Ukraine conflict. The measures restrict Lukoil's ability to raise capital on Western markets and its access to cutting-edge technology.

Alekperov, who became deputy energy minister of the USSR under Mikhail Gorbachev in 1990, is a survivor and is counting on Lukoil remaining independent, despite overtures from state-controlled rival Rosneft.

Igor Sechin, the head of Rosneft, is known to covet Lukoil in his bid to transform his company into a global energy champion on a par with ExxonMobil.

"There is no other mechanism to buy, apart from us selling," Alekperov, who is worth about $15bn, told the Financial Times. "So I do not expect any action to be taken against me. I am not providing any grounds for that."

Lukoil appears to be in a strong enough position to withstand any advances from Rosneft, which has hoovered up rivals TNK-BP and Bashneft in recent years.

On 31 October, the company disclosed that Alekperov had been awarded a commendation by President Vladimir Putin in recognition of his "contribution to the development of entrepreneurship, initiatives for the benefit of the society and years of dedicated work".

A former Caspian Sea oil rig worker, Alekperov, 67, plans to remain at the helm of the company for the next three-to-five years.

He told Bloomberg TV in October that he is continuing to look for a successor and that he doesn't think his son Yusuf can run the company.

"I hope that he [a successor] will be a worthy candidate who will continue the work of my life," said Alekperov. "If they ask me if he will be my son, I will say no, because this work is too complicated to give to my son, but he will remain in this business."

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