OAO Tatneft

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OAO Tatneft

Ul. Lenina 75
423400 Almetyevsk
Tatarstan
Russia
Telephone: 7 (8553) 255-856
Fax: 7 (8553) 256-865
Web site: http://www.tatneftjsc.ru

Public Company
Incorporated: 1994
Employees: 65,000
Sales: $5.18 billion (2000)
Stock Exchanges: New York London Russia
Ticker Symbol: TNT
NAIC: 213111 Drilling Oil and Gas Wells; 213112 Support Activities for Oil and Gas Operations; 23332 Commercial and Institutional Building Construction; 23493 Industrial Nonbuilding Structure Construction; 331491 Nonferrous Metal (Except Copper and Aluminum) Rolling, Drawing, and Extruding; 333132 Oil and Gas Field Machinery and Equipment Manufacturing; 42271 Petroleum Bulk Stations and Terminals

OAO Tatneft produces approximately 8 percent of all oil extracted in Russia, with an annual production of approximately 170 million barrels. The company ranks fourth in Russia in volume of extracted oil and holds the 30th place worldwide for oil production. Most of the company’s operations focus on oil exploration and production. However, Tatneft also holds stakes in oil refinement and retail concerns, as well as in businesses outside the oil industry. Those holdings include a telecommunications company, a tire production plant, and a diamond exploration company. In addition, Tatneft holds significant stakes in a number of financial services companies, such as the Moscow-based Zenit Bank and the Russian broker-dealer AO Solid.

Tatneft’s core facilities and operations are located in Tatarstan, a republic of Russia situated just north of the Caspian Sea. The name “Tatneft” is a combination of the word “Tatarstan” with the Russian word for oil, “neft.” This fusion in Tatneft’s name mirrors the real world situation, since close ties exist between the oil company and the local government. The Republic of Tatarstan holds one-third of Tatneft’s stock and relies on the company for about 30 percent of its yearly tax proceeds. The two entities have supported each other financially and politically since Tatneft was privatized in 1994.

The company’s activities, however, extend far beyond the borders of Tatarstan. Partnerships with Western companies began in the late 1980s. Joint ventures include ZAO Tatoilgas, a project with the German company Mineralöl Rohstoff to stimulate low-production wells and recover oil from sludge; ZAO Tatolpetro, a project with the French company Total to increase oil extraction using chemical methods; and Tatex, a project with the U.S. company Texneft to recover oil vapor from Tatneft’s holding tanks. Other international activities include the beginnings of projects in Iran, Iraq, and Mongolia. In all, Tatneft has business connections and agreements with companies in 20 countrie

Roots in Post-World War II U.S.S.R

The history of oil in Tatarstan begins in 1943, when the Bavlinskoye oil field became the first of a series of major oil discoveries in the republic. Five years later the Romashkino field, Tatarstan’s largest, was discovered. As the Soviet Union recovered from World War II, the government began taking steps to exploit its oil resources. The “Tatarneft” trust was established in 1949 for the development of the Bavlinskoye field. In April of the following year the Soviet administration adopted a decree calling for the formation of the Tatneft production association and giving it the right to develop the Romashkino oil field. Later Tatneft obtained the right to develop the republic’s second largest field, Novo-Yelkhovskoye. The two fields would be the source of most of the crude produced by Tatneft throughout the ensuing decades.

The 1950s and 1960s were marked by the acquisition of several smaller oil fields. Tatneft gradually became one of the country’s leaders in oil production. One of the most rapid periods of growth occurred between 1955 and 1959, when development at Tatneft accounted for half of the oil production growth called for in the Sixth Five Year Plan. The association worked to implement leading technology into the 1960s. Reserves at many smaller fields were depleted during that time, but production from the major fields continued to grow. In 1970, 783 million barrels of oil were produced, the highest yearly figure yet for the U.S.S.R. The mid-1970s, with average yearly production of over 700 million barrels, marked the peak of Tatneft’s production. By 1981, a total of two billion tons (14.2 billion barrels) of oil had been extracted in Tatarstan. As Tatneft’s main fields matured, production declined from the 1980s into the mid-1990s.

Becoming a World Player in the Early 1990s

Tatneft’s first move into the international arena came in 1989. That year the association signed a letter of intent to form Tatex, a joint venture with Global Natural Resources Inc. of Houston and Core Resources Inc. of San Antonio, Texas. The 50-50 venture was owned by Tatneft and by the American firms, who collaborated under the name Texneft. The goal of the partnership was to recover oil that was being lost through evaporation from Tatneft’s holding tanks. Global and Core contributed approximately $3.2 million to install 55 vapor recovery units. Tatneft expended a corresponding amount in labor and operation of the units. The vapor recovery project had several advantages. First, it would give Tatneft the opportunity to sell its product on the world market and bring in hard currency. Secondly, the vapor recovery units would reduce emissions of hydrogen sulfide and other contaminants.

The first shipment of vapor recovery units occurred in July 1991. By November, the units were in operation, producing about 12,000 barrels of oil in the first month. Tatex planned to take on further joint projects involving the development of wells in the Romashkino and Onbysk fields and the restoration of surface facilities on wells in the Romashkino area.

Meanwhile, the Soviet Union had ceased to exist. As Russia emerged from the ruins of the Soviet Union, Tatarstan was negotiating its degree of cooperation with the new federal government. Against a backdrop of political uncertainty, Tatneft took several steps to augment its role in the international oil industry. The association formed a special unit to develop ties with foreign oil and oil services companies. Tatneft also obtained the right to directly set up trade, economic, and technical agreements with foreign firms, and to export oil if the foreign currency proceeds were used for the realization of social programs.

These changes soon had concrete results. An exploration and development joint venture was set up with Manx Petroleum of London. Manx agreed to provide management, financing, and marketing for exploration in a 7,000-square-kilometer area in Northeast Tatarstan, while Tatneft would provide oil rights, manpower, and export services. In another overseas deal, the American Tatex venture took on the job of drilling or refurbishing 50 wells in the Onbysk field. A third international partnership in 1993 involved the Swiss firm Panoco S.A. Tatneft and Panoco agreed on a 50/50 joint venture to drill several thousand wells over the course of the next decade in eight Tatarstan oil fields. The project would provide access to about 2.6 billion barrels of untapped reserves. Although production from the joint ventures accounted for only a small part of Tatneft’s operations, the partnerships were useful in contributing new technologies and efficient techniques.

Privatization on Domestic and International Markets: 1994-98

Nineteen ninety-four was a groundbreaking year for both Tatarstan and Tatneft. The two entities clarified their political and corporate identities with the adoption of major changes. Tatarstan’s political situation had been up in the air since 1992, when the republic refused to sign the Federation Treaty. Because the predominantly Muslim Tatars differed in both religion and ethnicity from the Moscow center of power, Tatarstan decided to work toward complete independence. This strategy proved unfeasible, however, since the republic would have been surrounded by members of the Russian Federation and likely would have faced an economic blockade. Finally, in February 1994 negotiations with Moscow culminated in a treaty that made Tatarstan an associate subject of the Russian Federation. Under the treaty, Tatarstan won extensive economic and political powers that gave it a preferred status in relation to other members of the Federation. The republic was able to use its situation to create advantageous business conditions for Tatneft.

A month before Tatarstan joined the Russian Federation, Tatneft was privatized. Several state oil-related enterprises were combined with the old Tatneft production association to form a joint stock company, AO Tatneft. The new company hoped to solidify its national and international standing by stabilizing oil production with new technologies and extending its geographical reach. The Dresdner Bank was quick to recognize the new corporation, providing it with a $60 million line of credit secured by oil exports. Tatneft hoped to attract more investors by bringing its financial affairs into line with international standards. The firm hired ZAO PricewaterhouseCoopers as its auditor and brought in U.S. consultants Miller & Lents Ltd. to audit its oil reserves.

Company Perspectives:

Tatneft management has set the following mission: To become an internationally recognized oil company ensuring maximization of the company’s value on the basis of: strengthening, growing and effectively using the existing potential of Tatneft’s reserve base through an active capital investment program which, in the long-run, will reap financial benefits far exceeding the cost of raising capital; maintaining an industry leading position in profitability, technology and environmental protection; and in the long-term broadening and diversifying Tatneft’s resource base.

Tatneft succeeded in stabilizing its oil production in 1995. Production had been declining throughout the early 1990s because of a downturn in demand for crude oil in Russia and insufficient capital investment. The achievement of stable production mid-decade was due in part to a more favorable tax regime. Tatarstan granted Tatneft special status in 1995 that included lower than usual excise taxes and tax exemptions on low-productivity wells. Production also improved due to Tatneft’s well rehabilitation program, better recovery techniques, and the opportunity to bring non-operational wells into production. As a result, production reached 170 million barrels in 1995, a level that would remain fairly constant into the next millennium.

In 1996 Tatneft entered the international stock market, becoming the first Russian oil and gas concern to do so. The company issued 11.5 percent of its shares as American Depository Receipts on the London stock exchange. The shares were also traded on the Berlin, Frankfurt, Munich, and Stuttgart exchanges. The offering was well received and shares rose throughout the first three quarters of 1997. Although the company recorded a loss of $310.5 million for 1996, oil production remained steady at 168.7 million barrels and oil reserves increased for the first time in eight years.

International success occurred against the backdrop of tax confusion and payment problems on the domestic front. The federal government accused Tatneft of owing Ru 407 billion in back taxes. Tatneft countered that it had paid taxes in the form of fuel given to agricultural concerns, an in-kind exchange that the government had agreed to count against taxes owed. When fuel contributions were considered, Tatneft owed only Ru 42 billion, less than many other Russian businesses.

The barter system that Tatneft had used to pay its taxes was widespread throughout the Russian economy. A pressing problem for nearly all Russian businesses was a lack of payment from domestic customers. Most of Tatneft’s consumers lacked hard currency and preferred to pay in kind for oil. That situation pushed Tatneft to look abroad for financial support in the form of hard currency. Foreign banks, encouraged by a slight improvement in the Russian economy, were happy to oblige. With negligible debt at the end of 1996 and 6.3 billion barrels of reserves, Tatneft looked like a company that only required a little capital investment to bring its idle wells back into production. As a result, Tatneft won $528 million in short-term loans from Western banks. Those banks overlooked more unsettling aspects of doing business with Tatneft—primarily the fact that the company was handing cash over to the government to help Tatarstan pay its bills. The government got a total of $230 million from Tatneft before the economic crisis in 1998, most of which it later paid back in the form of deductions from Tatneft’s tax bill. But as long as Tatneft’s wells were pumping out hard currency profits, financial institutions put up with unorthodox business practices. At the end of 1997, their faith seemed to be justified, as Tatneft had a net income of $12.9 million on sales of $2.53 billion.

Although Tatneft was losing cash to the government, the company also benefited from a relationship of mutual assistance. Tatarstan President Mintimir Shaimiev attended the June 1997 annual meeting and made several recommendations. He offered government support for helping Tatneft become more vertically integrated, as the company still had no refining capacity. He also suggested that the company make moves to place its shares directly on American stock exchanges.

President Shaimiev came through on his promises in January 1998, when he signed an agreement with the president of Nizhnii Novgorod for Tatneft to provide oil to the NORSI refinery in that city. Tatneft expressed a desire to gain a controlling stake in the refinery, perhaps in an alliance with its competitor LUKOIL. As of 2001, Tatneft owned 8 percent of OAO NORSI Oil. The plans for increased presence on the international stock market also moved ahead. On March 30, 1998, Tatneft debuted on the New York Stock Exchange. By that summer, foreigners owned 22.5 percent of the company, while Tatarstan had 30.3 percent, Russian investors 16.8 percent, and Tatneft employees 30.3 percent.

Weathering the 1998 Economic Crisis

Despite these confident business advances, conditions in the Russian economy did not bode well for Tatneft. Stocks had been falling since the beginning of 1998 and the price of crude was low. In August 1998 the economy collapsed as the Russian ruble experienced a 245 percent devaluation. The downturn was especially disastrous for Tatneft, since most of its loans were denominated in foreign currency. To make matters worse, the company lost money through Treasury bills on which the Russian government had defaulted. Dealing with the enormous foreign debt burden would be the central problem of the next few years. Tatneft barely managed to pay a half-yearly coupon on its $300 million Eurobond, finally scraping together the required amount several weeks after the October due date. Year-end results for 1998 were understandably poor. The company lost $732 million on revenues which were half of the previous year.

At the beginning of 1999, Tatneft’s total debt was about $1.07 billion. The firm began paying its foreign creditors bit by bit out of its crude sales abroad, all the while carrying out negotiations on restructuring debt. Relations with Western debtors were complicated by the fact that several dozen banks had originally been brought together to provide loans to Russia, and they all differed on what the terms of the restructuring should be. Despite the difficulties, Tatneft could not afford to default on the loans. Besides losing international credibility, the firm would lose its main source of hard currency, since domestic customers continued to pay with barter and IOUs.

Key Dates:

1943:: First oil is discovered in Tatarstan.
1950:: Soviet decrees form the Tatneft production association.
1970s:: Oil production in Tatarstan reaches its peak.
1989:: Company establishes first joint venture, with American firm Texneft.
1994:: Tatneft is privatized as AO Tatneft.
1996:: Tatneft is listed on the London Stock Exchange, becomes OAO Tatneft.
1998:: Russian economic crisis causes Tatneft’s foreign debt to mushroom.
2000:: Tatneft restructures debt and begins seeking projects beyond its borders.

In spite of the bleak situation, there were some reasons for optimism in 1999. Tatneft made its biggest profit in five years, earning $311 million on revenues of $1.83 billion. Production was in line with previous years. The company also embarked on a project to expand its retail network from 80 gas stations at the time to 500 stations by 2005. They would be located near the facilities that refined Tatneft’s gas, in Moscow, St. Petersburg, the Middle Volga, and the Ukraine. The project was part of a trend toward increased vertical integration.

By the beginning of 2000, Tatneft’s debt still stood at $846 million. As negotiations with banks continued, the firm took advantage of several business opportunities. Tatneft diversified outside the oil sector with the purchase of a 78 percent stake in Tatinkom-T, a major telecommunications company in Tatarstan. Later in the year Tatneft acquired controlling stakes in a tire producing plant in Nizhnekamsk and set up a joint venture to search for diamonds in the northern Arkhangelsk region. Most of the acquisitions were made on the basis of share transfers.

May 2000 brought Tatneft’s first joint venture outside Tatarstan. ZAO KalmTatneft was formed in a partnership with the Caspian-area oil producer Kalmneft. The project would develop fields in Kalmykia, a southern republic on the northwest shore of the Caspian Sea. Because Tatneft’s own wells were low-producing, the firm was happy to find a way to use some of its recently hired staff and newly acquired equipment. Other expansion included the opening of an office in the Mongolian capital of Ulan Bator, to take part in prospecting and geological exploration in the south of the country.

In continued efforts to increase its focus on refining and marketing, Tatneft acquired a controlling stake in the Nizhnekamsk refinery, which had been a longtime buyer of Tatneft oil. Tatneft planned to upgrade the refinery to specialize in processing high-sulfur crude, of which Tatneft produced large amounts. Work on the complex proceeded at a brisk pace through 2000, and the basic refinery complex was expected to be completed by the end of 2001. Resources were also pouring into the gas station expansion project, which was helped with the acquisition of a stake in the retailer Mosnefteproduct.

As 2000 neared its close, Tatneft’s situation appeared to have improved markedly over the past years. Crude prices were almost double what they had been in the summer of 1998 and profits were predictable. Those factors set the stage for a final resolution of the debt problem. In November, Tatneft signed a debt restructuring agreement with a group of European and American banks. Under the agreement, the remaining $354 million of foreign debt would be paid back over two years at moderate interest rates. Year-end results were positive. The net profit of $842.5 million was up 131 percent from the previous year and sales of refined products had doubled their share from 1999.

In 2001 Tatneft continued to seek opportunities to develop oil fields beyond its borders. The firm gained permission to drill approximately 80 wells in Iraq under the United Nations oil-for-food program. The government of Sudan was also looking for a firm to develop its oil fields, since the companies currently active in the country had come under pressure from human rights activists concerned that the government was using oil revenues to fight rebels in the south. Since Tatneft appeared to be less vulnerable to protesters, the company signed an initial memorandum of cooperation with Sudan. Finally, Tatneft also initiated talks with Iran about the possibility of conducting seismological surveys there and installing well-reinforcing equipment. Tatneft appeared to have regained solid footing after the 1998 crisis, and was actively expanding into new sectors and geographic territory.

Principal Subsidiaries

ZAO Tatoilgas (53%); Tatex (50%); ZAO Tatolpetro (50%); Tatnefteotdacha (49%); AO Solid (55%); Zenit Bank (20%); Bank Devon Credit (53%); Mosnefteproduct (15%); Aktuban-neft; Almetevskneft; Aznakaevskneft; Bavlyneft; Dzhalineft; Elkhovneft; Irkenneft; Leninogorskneft; Nizhnekamskshina; Nurlatneft; Prikamneft; Shungutneft; Suleevneft; Tamashneft; Tatneftebitum; Elkhovneft; Yamashneft; Zaynskneft.