Conocophillips-Lukoil

SPECIAL REPORT

DEALS OF THE YEAR ConocoPhillips-Lukoil

One strange cocktail by Vipal Monga

On Sept. 29, 2004, Houston-based Cono- partnering with a U.S. oil producer was seen as a Putin peremptorily coPhillips announced it was paying $2 billion to step toward convincing international markets that dismantled Yukos, buy a 7% stake in Russian oil giant OAO Lukoil Lukoil was a well-run, transparent organization. jailing its CEO, from the Russian government. The news came But the oil company was wary of ceding control. Mikhail Khodor- amid a charged backdrop of war in Iraq and soar- “From the Russian side, they tend to look at U.S. kovsky. ing oil prices fueled by strong demand from the companies as overbearing, bureaucratic and arro- “You can imag- U.S. and China. In Russia, President Vladimir gant,” he says. ine what happens Putin was worrying the markets by moving to This was a major point. Lukoil was looking for in the board room take control of privately held oil producer OAO a big partner—but not too big. The company was when Lukoil man- NK Yukos, the country’s largest oil producer. wary of cutting a deal with a behemoth the size of agement is giving Despite this volatile landscape, ConocoPhil- ExxonMobil, whose market capitalization is about a presentation to Burdick lips and Lukoil managed to complete the largest 10 times that of Lukoil, or any of the largest oil Conoco on this deal privatization in Russian history and the largest in- companies. “It’s sort of their way or the highway,” and Khodorkovsky vestment ever by a U.S. company in Russia. A 7.6% Israel quips. “You can’t be equity partners with a is arrested and sud- stake has since grown to 10%, and an additional company the size of Exxon.” denly everybody $3 billion could raise that share to 20% over the Conoco seemed a perfect fit. For its part, Conoco says private capital next two to three years. Conoco now has one rep- needed access to new reserves. Oil companies have in Russia is dead,” resentative on Lukoil’s board, and the two compa- been investing heavily in developing oil projects on Israel says. nies will collaborate on joint ventures in Northern offshore sites or in regions such as West Africa. As Ironically, events Russia’s Timan-Pechora oil region and possibly in the Western oil industry consolidates, it’s grown such as Yukos’ Iraq’s West Qurna oil fields. more difficult for a company the size of Conoco to breakup and the war The deal was a deal of the year not just for its boost its reserves by buying competitors. in Iraq may actually significance but also because it was a creative solu- Russia has huge oil reserves and big, emerging have helped seal the Israel tion to strategic problems both sides faced. Conoco, companies to develop them, but the country, first deal. Given the neg- the third-largest U.S. oil company, gained access to under the Yeltsin-era oligarchs, then under Putin, ative international reaction to Putin’s moves, both billions of barrels in Russian reserves and a chance was still seen by many as too risky an investment. Lukoil and the Russian government had greater to develop fields in Iraq, while Lukoil obtained the “American companies have seen a lot of bad be- incentive to show that Russia remained open for backing of a respected U.S. oil company. For Lukoil, havior in Russia,” Israel says. “Contracts haven’t business. A deal with Conoco would be a counter- garnering Conoco’s support was a key driver to get- been honored, and deals have been broken.” weight to the Yukos situation. ting the deal done, says Rick Burdick, a partner at But despite misgivings on both sides, Israel and “All of these, in a strange cocktail, came to- Akin Gump Strauss Hauer & Feld LLP, the Wash- Akin Gump lawyers initiated talks in the spring of gether to help the deal,” Burdick says. ington-based law firm that advised Lukoil. 2003. It took over a year to get the deal signed. Moreover, with the U.S. embroiled in Iraq, it Lukoil’s reserves, the second largest in the Conoco CEO James Mulva and Lukoil CEO became expedient to do a U.S.-Russia deal, Israel world after Exxon Mobil Corp.’s, were being val- Vagit Alekperov spent the better part of 2003 adds. Both countries wanted to strengthen ties and ued at a large discount to Western companies’ re- and 2004 flying to cities such as Zurich, London thought a corporate union would help that cause. serves, Burdick explains. In fact, Lukoil’s reserves and Paris, meeting in unexpected places to avoid But while the deal was important for the cor- had a $1 per barrel value at a time when reserves being seen together. They struggled with complex porate ambitions of the two companies, its rami- held by companies such as ChevronTexaco Corp. issues of corporate politics and culture. “In a deal fications for investing in Russia in general may be and Exxon stood at $8 to $9 per barrel chiefly be- like this, senior management have to get together more significant. “It shows that a smaller com- cause markets viewed Russian companies with to develop a relationship,” Burdick says. “We knew pany can gain access to reserves in an area like some mistrust. “The Russians saw the valuation it was going to take time.” Russia, while Exxon hasn’t been able to expand issue as significant,” Burdick says. Burdick recalls that the process, involving there,” Israel concludes. “It says that if you’re a Robert Israel, a partner at New York-based translators, was at times frustrating, as both sides good corporate citizen, you can work within the investment bank Compass Advisers LLP, which grappled with major uncertainties. Conoco wanted frame of government legislation and get deals advised Lukoil, says that, from Lukoil’s standpoint, to ensure that its investment would be safe after done.” I