Interview with Sibneft president Eugene Shvidler

- What trends do you see in the Russian oil industry?

- Key players have become much more sophisticated. Everybody has learned their lessons from the 1998 financial crisis, and everybody understands what cost is. Major oil companies now have money and are ready for the next stage of development. Russia is a large producing country with fast growing, ambitious companies, which potentially, at some point, will become international players. In an era of high prices, there is undeniable production growth as oil companies begin to invest in drilling. This, of course, can eventually reduce the crude price, but higher production also leaves an option of entering into more sophisticated refinery processing deals. Sibneft, for one, is looking into processing deals in Eastern Europe and in Germany, in particular. As for oil-related legislation, the whole taxation system needs constant improvement, although now it's much more responsive to reality than it used to be. The law on bankruptcy in Russia is a fashionable instrument to acquire new assets, but I think the trend will fade out.

- Despite all the talk about further privatization, do you think the government will leave at least one company in the hands of the state? Is there any need for a national oil company in Russia?

- I think all oil companies will become private within the next three years. I do not support the idea of a national oil company because de facto it has already failed. Secondly, what can be the purpose of this national oil company, to earn money for the state or to be a non-market instrument in distributing oil products? By definition, the state should not run a commercial company, it should just receive taxes. The state should be present on the market via laws and regulations.

- Will it make sense for Russia to join Opec or any other producer organization?

- I think that in this case, the less limitations we have, the better. Look at Opec. It's not clear how it works, as everybody is violating established rules, and this is an open secret. In other words, the less interference from governments and intergovernmental organizations we have in the operation of the oil market, the better.

- Russia's oil exports are notoriously unpredictable, not in the least because they are a function of a great deal of wrangling and special deal making. The latest illustration is how Russia's government has so far failed, or may not have been trying very hard, to slow down the rising volumes of Russian crude exports. What are more effective ways of regulating oil export flows?

- The right thing to do is to regulate crude exports via duties and taxes. Physical restrictions and quotas do not work. I want to stress, again, that all players are now clever, they have the money and political influence, at least, not to be discriminated against in their crude exports. The principle of all producers having equal access to space allocations in export pipelines should be abided by. When additional volumes are allocated to individual companies to finance various state projects, it's bad for everyone. However, all oil companies are trying to participate in these extra crude exports; it has become a market in its own right. The principal issue is the origin of various state-backed programs financed out of crude export earnings. This is politics, and not due to a lack of funds in the federal budget. I do agree that, for example, state pipeline operator Transneft should not have its trading arm involved in exporting crude for one of the state-backed projects, but it is more useful to understand, in this case, who is benefiting from a particular project. On the whole, I believe that one third of crude production allocated for exports is enough for any company. That's enough at any oil price and is an issue of how the company works.

- How does Sibneft work?

- We have a business plan for five years, drawn up at the price assumption of $16 per barrel with a 22% discount rate. That price is part of our philosophy. You can put in a price of $30/bbl, and projects done at this assumption will not be profit making. Or the opposite, you can assume the price of $10/bbl and then you can afford very few things. Sibneft is well positioned for organic growth. Everything is geared to develop reserves without merging with another company: We are cash-rich, debt-low, etc., etc. As for production cost, I think we are more advanced here than anybody else in Russia, our direct production costs are currently at 89?/bbl. We have the same philosophy as Surgutneftegas. First, we want to fully develop the resources located in West Siberia, our home base. At the same time we have a better location than Surgutneftegas, which is surrounded by other companies. Our Omsk refinery and producer Noyabrskneftegas are situated in a historically protected area. Let's say anyone who acquires an oil field in that area would be forced to use our infrastructure. I am not saying this is impossible but it will make such a move more expensive.

- After production fell last year, how urgent is it for you to raise production and keep the company balanced?

- We are looking to balance crude volumes at the production end with what we need for exports and refining. We see a shortage of some 40,000 barrels a day, or 2 million metric tons of crude, which we buy on the market. Normally speaking our company is well balanced between production and refining, but given growing exports, there is a problem. Sourcing crude becomes difficult, and it's not a question of the price, but of physical availability. We cope with this problem for now, but we do not need this. So, we should either hike production by 40,000 b/d, which is what we are trying to do now, or buy some oil assets on the market. These are two completely separate issues tackled on a parallel basis by different teams.

- How do you choose between raising output or buying new assets? Which makes more sense in the present political and economic climate in Russia?

- We could immediately boost production, but that is not within the lines of our business plan: We have other projects that yield a higher return from the same funds invested. We could achieve a desired physical volume but we might miss some opportunity elsewhere as a result. Our philosophy is to make money. It's all the question of timing. Maybe some people want to see the results in a hundred years, others are aiming at a shorter time frame for return on investments.

- Talking about asset acquisition, how can you explain that a medium-sized regional company Onaco was sold for $1.08 billion? Sibneft, as one of the bidders, was also ready to pay $1 billion. Is Onaco worth that much?

- I was looking at different companies. Nobody liked Onaco, which has an old asset base, and besides, the company has, for longer than others, been run by the local administration, which also had a detrimental effect. We did our standard evaluation and made three models of the company profile. In addition, we took into account that we control more than 40% of Orenburgneft, the key producer of Onaco, and then we reached a certain price figure which was less than the $1 billion we put up at the tender. Our 40% stake in Orenburgneft is worth at least that much of a share of Onaco, because the other assets - the refinery and retail unit - have negative value. We could pay a premium for total control. In our hands, the 85% stake of Onaco that was put on sale has a higher value than it has for Tyumen Oil Co, which won the tender by paying $1.08 billion.

- Did you hold talks with other bidders before the tender to reach a certain agreement to avoid overpricing?

- Yes, we held talks with all interested parties, and all of us defined our interests. As a result, participants in the tender were the companies which said they would be interested to compete in price. Tyumen Oil Co. overpaid. I told them beforehand that we have a stake in the producer, which we acquired from Yukos at a large premium. The price TNK paid was not economic. It is the price of people who expect to make money only in a hundred years. The price paid requires high oil prices to stay for a long time, simply to pay interest on the debt taken on to take part in the tender.

- How are you going to deal with the situation when you own a significant stake in the producer while Tyumen Oil Co. owns a major stake in the company itself?

- I do not see any immediate asset swaps that we can do. There are several options. We can live on dividends as a shareholder or we can divide the crude produced. Our shareholding in Orenburgneft now naturally becomes more expensive if they want to buy us out.

- Part of your asset acquisition strategy was buying out independent producers. Are there any imminent purchases?

- We have a special team which makes evaluations. We are examining the potential of all independent producers with an output of around 20,000 b/d. Firstly, those located in Western Siberia. For example, there is Sidanco's bankrupt unit Varyoganneftegas which is using our infrastructure. Certainly, we are not going to get involved in the current tussle over Varyoganneftegas, but we could try to buy it, if it is put up for sale. Then we are very much interested in the Timan-Pechora oil and gas province in Russia's north. It is both a lucrative and challenging region with serious prospects. However, nothing will happen there if you try to apply Soviet methods. It is not only about linking up with Lukoil, which is now active in the region, but all the players there will have to cooperate as we are talking about very serious investments. Our plan is to enter Timan-Pechora both by bidding in tenders for separate oil fields and acquiring local independent producers.

- Why is Sibneft shying away from projects abroad - unlike many other Russian majors which are keen to establish a presence in Iraq, Iran, and Libya?

- In the medium term, we see our niche as a company focused on the Russian upstream, although participating in projects overseas would certainly help mitigate the risks associated with investments in Russia. For a company with a large base of low-cost, high-quality reserves - and we now hold some 4.6 billion bbl of proven reserves - it makes more sense to concentrate on acquiring expertise through partnerships with foreign companies in our home market. Besides, for some time the political background in Russia was not conducive for us to go into overseas ventures. However, we feel that, for example, in Iraq we can successfully compete with others for developing Iraqi oil fields once the sanctions are lifted.

- You mentioned partnerships with foreign companies. What kind of strategic alliance best suits your interest at the moment?

- We tried it three years ago, teaming up with Yukos and angling at a deal with Elf Aquitaine to buy an equity stake in the merged company. We have advanced very far since then. We have haggled over the issue of cost for three years. The deal with Elf has taught us a lot. We are no longer keen to sell a stake to oil companies, we need expertise. Upstream science is moving ahead, and we want to learn. That is why we are looking for cooperation with service companies and are outsourcing logistics. We already have agreements with international service companies Schlumberger and BJ Services. We shortly hope to sign an agreement with a third oil field service provider, Halliburton. They do not take equity risk, and perform only service functions. The issue of a strategic partnership may arise if we gain a big asset in Timan-Pechora and would be looking to share the costs.

- Sibneft was the first Russian company which announced plans to create an electronic trading platform for crude and products trading. What made you hope such a project can be a success in Russia?

- Yes, we have launched such a project in cooperation with state pipeline operator Transneft and oil products pipeline operator Transnefteproduct. We have drawn up a business plan and aim to hold trial tenders. Frankly, we do not expect big revenues from the project. The goal is to finally free Urals from its dependence on Dated Brent, and to create a separate, more transparent market for our crude. Traders would talk, and we think the costs of the selling process itself would go down.

- Unclear shareholding structures remain a worrying aspect of many Russian oil companies. Can you reveal who the principal shareholders are in Sibneft?

- First, I would like to say that Sibneft is a separate oil company not mixed up with the aluminium interests of our shareholders. As for the list of shareholders, Roman Abramovich controls about a 40% stake, a similar amount is controlled by the company's top management, while the rest is in free float. I would also like to underline that the Chorny brothers [metals magnates who handed over their aluminium assets to Sibneft shareholders at the beginning of the year] have never been and are not represented in Sibneft.