White Nights and Polar Lights - Investing in the Russian Oil Industry

WHITE NIGHTS AND POLAR LIGHTS: INVESTING IN THE RUSSIAN OIL INDUSTRY

Abstract

This paper aims at investigating the feasibility and strategies to be adopted by Western firms

potentially interested in the Russian Oil Industry. Bringing evidence from three real cases, our study

will deeply analyze possible courses of action and define a suggested one.

We will start from a presentation of the industry's opportunities and threats using Porter's Diamond of

the determinants of National advantage, which will allow us to esteem importance and value of the

acquisition of Russian oil to a Western oil firm. The second section of the paper will deal with an

examination and comparison of the strategies adopted by Phibro, Mobil and Conoco in their

developments during the early 90's, highlighting positive and negative decisions they've taken at that

time. Primarily based on those findings we will clarify our view about Russian Oil sector and

measures to be implemented by Western companies in order to hedge or protect their investment.

INDEX

1. Russian Oil Industry

1.1 The origins

1.2 The transition

1.3 The acquisition of Russian Oil and Western companies

1.3.1 Incentives

1.3.2 Risks

1.3.3 Valuation of Acquisition of Russian Oil

2. Phibro, Mobil and Conoco : when, why and how

2.1 Phibro

2.2 Mobil

2.3 Conoco

2.4 A comparative look

3. Ways to protect investments in Russian Oil

1. Russian Oil Industry

1.1 The origins

1870s-1900s:

The first large-scale entrepreneurs of Russian oil industry were foreigners, while the state only

intervened to collect taxes from foreign ventures.

By the turn of the century, Russian oil was a major factor in the world market.

1900s-1980s

Foreign investors were pulled out after the Revolution was launched and Russian oil stayed under the

sole direction of the state for 70 years since 1917. Responsibilities for the industry were divided

among several ministries. Hierarchical authority, conflicting goals and split responsibility pushed the

industry towards inefficiency and over-production.

By the mid-1980s, production fell by 1/3 while exports by 1/2.

1.2 The transition

1980s-now

After the collapse of the Soviet empire, Russia reopened its oil industry to the outside world. It was

virtually virgin territory for the oil firms, comparable in many ways to the earlier great discoveries in

the Middle East and Africa. If the major firms didn't establish themselves quickly in Russia, they

risked being permanently excluded from one of the world's largest single sources of crude petroleum,

which was a serious disadvantage since most of the other large sources of crude were located in the

perpetually unstable Middle East.

3

1.3 The Acquisition of Russian Oil and Western Companies

Let's now list the incentives and risks associated with a potential expansion in Russian Oil market by

Western Companies.

1.3.1 Incentives

1. Russia was the world's largest single producer of crude petroleum. Its reserves of petroleum were

the seventh largest in the world, and its reserves of natural gas the largest.

2. Close to European and Japanese market, boasted an existing network of pipelines and refineries

capable of serving Western Europe.

3. Rising inflation counterbalanced the currency risk from the exchange

Taking the opposite standpoint, Western oil firms were needed for their capital, technology and

managerial talent. They were expected to restore the production level of long neglected fields and

provide the government with a valuable source of hard currency to finance industrialization and

political reforms.

1.3.2 Risks

1. Hierarchies of control were complicated and changed rapidly

2. Legal system was underdeveloped

3. Cultural distance and new market development

4. Taxes on oil sector were unpredictable and very heavy;

5. Oil sector remained price controls, so that domestic fuel prices were far below international levels

and even below the cost of production.

1.3.3 Acquisition evaluation

Evaluating an investment in Russian Oil by a Western company is not an easy task due to the high

level of involved uncertainty which calls for extensive trade off assessments. This can be done either

in qualitative terms, as already done in previous points, or using a more quantitative approach

exploiting traditional valuation techniques such as the DCF methodology, or newer