OAO NK YUKOS

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OAO NK YUKOS

26 Ulansky Pereulok
103045 Moscow
Russia
Telephone: ( + 7) 095 232 3168
Fax: ( + 7) 095 755 5393
Web site: http://www.yukos.com

Public Company
Incorporated: 1993
Employees: 85,000
Sales: $8.5 billion (2000)
Stock Exchanges: MICEX RTS MSE OTC Bulletin Board
Ticker Symbol: YUKO; YUKOY (OTC)
NAIC: 211111 Crude Petroleum and Natural Gas Extraction; 213112 Support Activities for Oil and Gas Operations; 324110 Petroleum Refineries

OAO NK YUKOS is the second largest of Russia’s integrated oil companies, with an estimated 11.8 billion barrels of oil reserves in its western Siberian fields and an average production of one million barrels a day. With holdings in numerous sectors of the oil industry, the company accounts for 15 percent of oil produced and 15 percent of oil refined in Russia, and also operates a domestic retail network of approximately 1,200 gas stations. Oil extraction at YUKOS is carried out by three main production units. Yuganskneftegas, in western Siberia, accounts for 62 percent of total production. Remaining production is shared between the Tomskneft association in Central Siberia and the Samaraneftegas association in European Russia. Refining occurs at five separate facilities. The Novokuybyshevsky, Kuybyshevsky, and Syzransky refineries are located in the Central Volga region, while two more refineries are located east of the Ural Mountains in the cities of Achinsk and Strezhevoi.

YUKOS is a company with international reach. It exports 45 percent of its crude oil to Asia and Europe. In addition, foreign companies are partners in several development, production, and field services enterprises. The company’s shares are traded as level one American Depository Receipts (ADRs) in London, Frankfurt, Munich, Berlin, and in the United States on the OTC Bulletin Board. Domestically, YUKOS is listed on the three major Russian exchanges: the Russian Trading System, the Moscow Interbank Currency Exchange, and the Moscow Stock Exchange. The company is headed by Mikhail Khodorkovsky, who, after going through a period of rocky relations with investors, is gradually regaining credibility with efforts to improve corporate governance and transparency. Khodorkovsky and his affiliates hold about 69 percent of the company.

A State-Held Company in the Early 1990s

YUKOS was formed in the early 1990s as part of the postcommunism process of transforming state concerns into joint stock companies. When the USSR fell apart at the end of 1991, dozens of individual local oil concerns existed. The entire oil sector was in need of restructuring, as production had fallen since the mid-1980s due to poor maintenance and technical problems. It was decided to assemble a limited number of large integrated companies from the various pieces of the oil industry. Following a presidential decree on privatization in April 1993, NK (Neftyanaya Kompaniya, or “oil company”) YUKOS was formed as a joint stock company uniting the Yuganskneftegas production concern, three refineries in the Central Volga region, and several smaller operations relating to the sale of refined products. YUKOS’s major competitors, created under the same decree, were LUKOIL and Surgutneftegas.

While YUKOS’s daughter companies went through the process of privatization, the parent company remained state-owned. The government chose Sergei Muravlenko, former head of Yuganskneftegas, to lead the company. In its first year of operation, YUKOS developed a joint venture with Shell and the Canadian company Fracmaster. The first joint venture in the Russian oil industry, the “Yuganskfracmaster” partnership worked on well stimulation in the western Siberian fields. A second joint venture, “Yusat,” focused on refining. In an agreement with Eser Foreign Trade of Istanbul, the Yusat venture allowed Siberian crude to be processed at Turkish refineries. The retail end of business was also developed early on. In 1993 YUKOS began building service stations in the Moscow area.

Production levels at YUKOS declined substantially in 1994 and 1995 due to the destabilizing effect of sweeping structural changes in the Russian economy. Nevertheless, exports increased gradually, making use of an already existing link to the Druzhba pipeline into Western Europe. With a total 1994 production of 198 million barrels, YUKOS accounted for 11 percent of Russia’s oil output that year.

As the economy began to stabilize near the end of 1995, YUKOS directed the proceeds from exports toward the rehabilitation of idle wells and the production of new anti-corrosive pipelines. That fall the company grew substantially when the production concern OAO Samaraneftegas, along with several affiliated research, development, and marketing organizations, became part of YUKOS. With the acquisition, YUKOS moved past Surgutneftegas to become the second largest company in terms of oil reserves. But growth only exacerbated management problems at YUKOS. Each daughter company had its own management philosophy, often based on Soviet traditions such as meeting quota and dealing in barter rather than profitability. As a result, the company fell behind on payment of salaries and amassed a $3.5 billion debt to the Russian treasury.

New Ownership, Active Leadership: 1995–98

Financial difficulties led to the privatization of YUKOS in a series of auctions. In early 1995, the cash-strapped Russian government had offered shares in state-held assets as collateral for loans from a select group of private banks. When the government defaulted on its loans, state companies fell into private hands. A controversial auction in December 1995 resulted in the sale of a controlling stake in YUKOS to Menatep Bank for $350 million. The modest price for such considerable assets was alleged to be a result of close connections between the government and the head of Menatep, Mikhail Khodorkovsky. Khodorkovsky was a former Communist Youth League leader who became a prominent player in the post-1991 privatization process. It was expected that he would now redirect his attention from Menatep to YUKOS, as he announced plans to clean up the company’s finances, court foreign loans, increase export revenues, and solve the problem of back taxes.

Khodorkovsky replaced Muravlenko as CEO in May 1996 and was elected to the board of directors. In December 1996 another “open auction” allowed Menatep to increase its holdings in YUKOS to an estimated 85 percent. With foreign investors and other competitors excluded from participation in the auction, a previously unknown company with, as the Wall Street Journal reported, obvious connections to Menatep paid $160 million for a substantial stake in YUKOS.

In 1997 YUKOS managed to restructure its tax debt in negotiations with federal and regional governments. Khodorkovsky pushed for the adoption of accounting and management methods that matched Western standards and produced a plan to address environmental problems by replacing more pipeline. He also traveled abroad that spring in an effort to lure foreign financial support, and eventually won an $800 million loan from an international syndicate. The loan, secured by oil exports and pledges of YUKOS stock, was used to acquire a controlling stake in the state-owned Eastern Oil Company. Eastern Oil, the 12th largest producer in Russia, operated several concerns in central Siberia, including the Tomskneft production entity and the Achinsk refinery.

Khodorkovsky’s success in finding foreign support led to a conflict with Amoco Corporation. Back in 1993, Amoco had won a tender to develop the massive Priobskoye field in western Siberia, with an estimated four billion barrels in reserves. After four years of talks and more than $100 million already invested in the project, Amoco had not yet established a concrete joint venture. Now that YUKOS had found financial support elsewhere, the Russian company asserted its right to develop the field independently. Negotiations with Amoco neared a breakdown point. After a brief revival of talks, Amoco officially renounced its plans for Priobskoye in August 1998.

Retrenching During Crisis and Conflict: 1998–2000

In early 1998 YUKOS announced plans to merge with AO Sibneft, the seventh largest oil company in Russia. Industry observers marveled at the potential size of the new holding company, to be called ?? Yuksi—its reserves would be greater than those of Royal Dutch/Shell. However, the merger was doomed by economic problems on the horizon. With oil prices falling, YUKOS defaulted on a $500 million loan after failing to meet its export targets. The merger was called off amid concerns over the financial status of both companies.

In August 1998 an economic crisis leveled the Russian economy. The country had been dependent on oil exports for producing foreign currency and tax revenues. Squeezed by low oil prices, the whole economy collapsed as the ruble plummeted in value and the government defaulted on its debts. Khodorkovsky emerged from the crisis with significantly weakened control over YUKOS. Menatep Bank had collapsed and defaulted on loans, which meant that shares pledged as collateral ended up in the hands of Western banks. Germany’s West Merchant Bank, Daiwas of Japan, and the Standard Bank of South Africa together gained control of 32 percent of YUKOS.

Company Perspectives:

Yukos’ mission is to become one of the locomotives of the Russian economy and to assist the country in emerging from economic crisis. “Leadership. Progress. Responsibility.” These are the components of our company’s success.

Yukos’ activity is directed toward the generation of profit in conjunction with ceaseless development and the consideration of the interests of society and the government. Yukos relies on the professionalism of its employees, innovation, initiative and the creative efforts of a whole collective.

In the midst of this bleak situation, YUKOS saw a need for fundamental change. In late 1998 the company initiated a major reorganization of its operations to match a Western model. Western consulting firms were brought in and advised a switch from geographic management to management based on the separation of upstream, downstream, and corporate business activities. Two management companies were created: YUKOS EP (Exploration and Production) and YUKOS RM (Refining and Marketing). The central apparat, or organization, under the name YUKOS Moscow, worked on forming a broader development strategy. The day-to-day management of production concerns was handed over to individual facilities, and noncore activities were spun off into limited partnerships. Many employees were transferred to these partnerships, lowering payroll costs for YUKOS.

The reorganization was successful in that it lowered the cost of production by almost half. Daughter companies, which had been set up to be self-sufficient, now benefited from the efficiency of centralized repair and construction activities. In a later stage of the reorganization, YUKOS began working with the oil field services firm Schlumberger Ltd. A continuing partnership with Schlumberger helped maintain efficient practices in the Priobskoye oil field and in the area of information technology services. While these changes would improve YUKOS’s bottom line in the future, year-end results for 1998 were poor. The company reported a net loss of $680 million.

The following year brought an attempt by Khodorkovsky to make up for the shares that had been lost to foreign banks, a move that sparked allegations of wrongdoing from investors. Specifically, he decided in April 1999 to issue 77 million new shares in YUKOS’s three production subsidiaries, more than doubling the number of shares in the companies. The new shares were sold to little-known offshore companies that were suspected, according to the Washington Post, of having ties to YUKOS. Investors had long had poor relations with Khodorkovsky, alleging that he stripped profits from subsidiaries by buying their oil at rock-bottom prices and then exporting the same at open-market prices; now the conflict erupted into the open. Billionaire investor Kenneth Dart was the most prominent voice of investor discontent. He owned a 10 percent stake in the production subsidiaries, and accused Khodorkovsky of attempting to dilute his holdings. Khodorkovsky in turn excluded Dart’s representatives from shareholder meetings. The chairman of the Russian Securities Commission launched an investigation into the affair and eventually resigned in protest against the conduct of YUKOS. The conflict was not settled until December 1999, when Dart sold his shares and YUKOS managed, in negotiations with shareholders, to regain control over 90 percent of its subsidiary stock.

Emphasizing Transparency in the New Millennium

With YUKOS firmly under the control of its management and the economic crisis receding into the past, 2000 promised to be relatively calm as well as profitable. Net income in 1999 had reached $1.3 billion, which exceeded competitor LUKOIL’s earnings despite YUKOS’s lower production level. Strong oil prices made even better results likely for 2000, and prompted YUKOS to move ahead on several fronts. The company continued developing the Priobskoye oil field, planning to invest $1.6 billion over the next five years to tap the massive field’s reserves. In June YUKOS announced plans to build a pipeline from Angarsk, Siberia, to Beijing, in an agreement with the oil pipeline monopoly Transneft and China National United Oil Corp. The project, expected to begin in 2005, would cost about $1.7 billion.

Some analysts questioned whether YUKOS had the assets to support its investments. The conflict with Kenneth Dart was still fresh in investors’ minds and had the potential to complicate attempts to find international financing. Consequently, YUKOS took steps to demonstrate the sincerity of its new investor-friendly image. In June the board of directors approved a corporate governance charter that provided for quarterly U.S. GAAP financial reporting, a transparent management structure and “arm’s-length” transactions with all parties. The board also authorized payment of the company’s first dividend. YUKOS’s actions paid off in August, when the company won a $50 million syndicated loan from Western banks. Khodorkovsky summarized YUKOS’ new approach in a meeting with reporters early in 2001. According to the New York Times, he sat at company headquarters under a sign reading, “Honesty, Openness, Responsibility,” and told reporters, “There has been a change in mentality. People now understand that transparency, good relations with investors and honest behavior in the market in the short term is to your advantage.”

Results for 2000 seemed to corroborate Khodorkovsky’s new strategy. Net income was $3.3 billion on net revenues of $8.5 billion. Average daily production had increased by 10,000 barrels per day over the previous year, and now stood at 991,000 barrels per day. High oil prices and increased exports were major drivers behind the year’s financial success. In 2001, YUKOS continued to capitalize on its strong standing with more acquisitions. In June the company bought a 27 percent stake in the Lithuanian Mazheikiu Nafta refinery, with the understanding that YUKOS would supply crude there and upgrade the Lithuanian facilities. Another acquisition followed in October, when YUKOS paid $30 million for 22 percent of the Anglo-Norwegian engineering group Kvaerner ASA. Kvaerner was expected to help develop the Priobskoye field. The deal, which rescued Kvaerner from financial difficulties, marked a turnaround from the days when Russian companies were courting Western investors.

Key Dates:

1993:: A presidential decree creates YUKOS from several separate oil entities.
1995:: The production concern OAO Samaraneftegas becomes part of YUKOS.
1996:: Mikhail Khodorkovsky acquires YUKOS and becomes CEO.
1997:: YUKOS acquires Eastern Oil Company.
1998:: YUKOS begins a major reorganization after the Russian economic crisis.
1999:: Conflict with investors tarnishes YUKOS’s reputation.
2001:: YUKOS regains investor confidence with a new focus on public relations and open communication.

December brought a mild check on YUKOS’s aggressive expansion. In a compromise with the Russian government, the six major oil producers agreed to cut their oil exports by 150,000 barrels per day. The decision was made in a concession to the OPEC countries, who were trying to maintain world oil prices at a high level. YUKOS had opposed the cut, preferring to expand exports as much as possible. Under the deal, companies remained free to export larger volumes of refined oil. YUKOS had shown an ability to adapt in the first decade of its existence, and would likely be able to adjust its mix of production, refining, and retail activities to market conditions.

Principal Subsidiaries

OAO Yuganskneftegas (91.7%); OAO Tomskneft VNK (75%); OAO Samaraneftegas (94.8%); OAO Novokuybyshevsky NPZ (91.4%); OAO Kuybyshevsky NPZ (95.2%); OAO Syzransky NPZ (94%); OAO Achinsky NPZ (42.3%); East Siberian Oil and Gas Company (68%).