The year 1997 was decisive for Russia and its oil companies. It was the year when the economic crisis ended and economic growth started. After a long decline, oil production increased. Most companies have new private owners. Oil companies made their presence felt on the stock market. Some of them, in particular LUKOIL and Tatneft, are recognized around the world. Most oil companies made up their mind about the market restructuring and chose international auditors. The debts owed by the oil industry to the federal budget have been cut. On the whole, the industry has been reorganized and economic growth is about to start.
Oil companies must plan their growth in a new competitive environment and see to it that the growth is reliable and meets social and ecological criteria.
Are certain criteria and principles widely accepted in most countries applicable to Russia, which is making a transition to market economy?
The experience of LUKOIL, the largest Russian oil company, suggests that stable development of large industrial, in particular oil, companies is the mainstream for Russia's economy.
Oil companies must work for simultaneous and comprehensive expansion of their resources and production potential, while improving their financial performance and assuring social and ecological safety. This implies that long-term and stable increase of profits, a major criterion of success in a market economy, must be backed by continuous expansion of reserves and industrial potential so as to make the financial gains stable. At the same time, social problems must be tackled and ecological safety assured.
Efforts to this end have been made before, but their comprehensive balanced long-term planning began only in the framework of the new concept of stable development. This is the reason why LUKOIL, which adapted to the market environment before the others, has restructured and expanded their production. A strategic concept of stable development, covering all its subsidiaries, was approved by its board in 1997.
Before working out the concept, the company thoroughly analyzed the experience of the world's most advanced oil companies such as Exxon, Shell, Chevron, Mobil, ARCO and Texaco.
We also analyzed the experience of the Russian and Soviet oil industry, which also proved valuable.
The analysis of LUKOIL's own performance in 1995-97 was equally insightful.
LUKOIL's work force remained the same in 1993-96 but its oil production as a percentage of the nation's total increased from 13.8% to 19.4% while refining amounts advance from 8.4% to 11%.
In 1997, company' production and sales continued their steady growth, with oil and product output increasing by 6% and 18%, respectively.
In financial terms, the net revenues in U.S. dollars increased over three years 4.4-fold and the net profit 2.4-fold.
The increase of oil production, refining and sale costs slowed down significantly in 1997. This trend is expected to intensify significantly in various activities and branches of the company.
Our investment program enhanced production and sales. Capital expenditures in the company's subsidiaries exceeded 6.5 trillion non-redenominated rubles in 1997. The company invested heavily in its foreign projects, in particular in Azerbaijan and Kazakhstan.
The company introduced new tools for attracting finances. It issued depositary receipts for its preferred stock, obtained a credit rating and borrowed hundreds of millions of dollars on the world market to finance its long-term strategy.
Despite the world financial crisis, the price of LUKOIL's shares appreciated 1.8-fold.
The performance analysis of foreign and Russian oil companies enabled the company to plan its stable long-term development until 2010 and, in certain cases, for even longer time spans. This long view makes it possible to plan investments in the development of oil fields, construction of refineries and expansion of the marketing infrastructure. The natural life of investment projects in the oil industry, ranging from 10 to 25 years, calls for long-term strategic planning, forecasting and management.
Choice of Strategy
The choice of strategy for stable development is dictated by strategic marketing, which evaluates the outlook for variation of demand, supply and prices of oil and products.
The level and variations of demand are the most powerful external factors influencing the stability of development. In the context of an economic crisis, weak and even shrinking solvent demand on the domestic market is the chief obstacle to stable development of oil companies. It brings about non-payments, surrogate payment instruments, idling of production capacities and other problems.
Crude oil is in demand on foreign markets but the amount which can be transported for export is limited and the domestic demand, albeit insolvent, cannot be ignored.
With the dynamics of demand and the difference between domestic and international prices as they are, increasing exports of oil is the chief tool of keeping oil companys' finances steady.
Russian oil companies face fierce competition in foreign markets while in Russia's border areas and large cities competition is also felt. This factor is bound to influence both demand and prices inside Russia.
The strategy of stable development anticipates that high competition in the petroleum product market will result in stabilization of prices and, consequently, lower profit rate, as is the case now in Europe and the United States. Consequently, only increasing amounts and better quality of petroleum products, and expansion of the product marketing network can lead to higher profit and effective investments in this sector with lower profitability.
Russian oil companies can borrow on the international financial market, provided that foreign creditors have an access to information on the company's financial health and outlook. International financial accounting and reporting standards have to be introduced.
Since 1996 we have been entrenched on the international capital markets and intend to consolidate our positions there. What is important is that partnership relations have started with ARCO, a U.S. company which has become the first strategic investor. The LUKARCO joint venture is the largest in Russia and one of the largest in the world.
Taxation legislation should be amended so as to encourage investments. Furthermore, a comprehensive law must be passed on production sharing agreements and the Mineral Resources Law has to be amended so as to enable the oil companies rather than their subsidiaries to hold licenses for prospecting for and production of oil.
The comprehensive recognition of marketing, financial, political and other factors made it possible for our company to work toward being competitive in the world market, which significantlyimproves long-term development.
LUKOIL's vertically integrated structure, which covers all stages of the oil business from the well to the gas station, also adds to stability of development for our's and other oil companies.
The strategic goal of oil companies is to increase profitable reserves of oil which should sustain production for at least 13-15 years. In LUKOIL this figure is 25-30 years. According to Miller & Lents, an independent U.S. company, proved reserves of LUKOIL in Russia alone exceed 11 billion barrels and tend to increase. Quality indices of the reserves, such as size of oil fields, daily output of an oil well and geographical position of wells, as well as the oil composition and others, are major variables in the model of stable development.
Much is being done and our company has started implementing long-term operations in new Caspian offshore fields in Russia, Azerbaijan, Kazakhstan and, in the near future, in other parts of Russia, above all in the Timan-Pechora area. The more abundant and cheap oil from the Caspian and other areas in Russia and abroad must partially replace the hard-to-recover Siberian oil.
This should not be construed as a call on oil companies to abandon Western Siberia. Caspian oil will reduce the load on Western Siberian operations and make it possible to replace the worn and obsolete equipment there and introduce new technologies. This will make stable and, most importantly, cost-effective oil production in Western Siberia a realistic proposition for a long time to come, with most Russian oil companies operating in that part of the country.
International operations is another field expansion essential for stable operation of Russian oil companies. In our case they are to exceed 20% and eventually 30% of our activities. LUKOIL will try to resume cooperation and win back markets in former Soviet republics and other countries with which close political and economic ties used to exist.
Oil companies should restructure to reinvigorate themselves, survive in the tough environment of today and assure their stable development.
The list of systemic changes in the management of oil companies with a view to assure their stable development includes:
- organizational and economic consolidation of the company and its subsidiaries;
- drastic improvement of the financial management, above all in the field of budget, accounting, cost control and marketing management;
- setting up of powerful marketing systems;
- development of advanced integrated information control systems;
- improved management of human resources.
The concept of stable development is itself undergoing continuous overhaul. It is updated with findings of the analysis of the company activities while software for multivariant computation is continuously improved.
Model computation of oil companies' futures does not eliminate reliance on human managerial and engineering expertise because such practice cannot be fully represented by its electronic analogs and life can spring political and economic surprises on us any time.
Still, the modeling of stable development predicts numerous dangers and possibilities enabling us to prepare for them.
Development and management strategies of today will assure to an increasing decree the positive growth of Russian oil companies. The result will depend on how sound and comprehensive the strategies are.
