Transcript Lukoil - NYU Stern

Group Members:
Violetta Abramova
Dennis Hwang
Luba Jacobson
Valerie Kritsberg
George Oka
Our Agenda Today:
•
•
•
•
•
Introducing…
Political Conditions
Economic Climate
Valuing the Firm
Conclusion and Recommendations
Decisions, Decisions, Decisions…
Why LUKOIL?
Because…
● Given the current economic & political conditions in
the world, the future of oil industry affects us all
● Large multinational & the fifth largest oil supplier
in the world after Exxon Mobile
● Improvement of corporate governance control &
relative financial strength of its equity shares on NYSE
& LSE place the company in a strong position
Introduction to LUKOIL
The World Over!!!
•
Global player and Russia’s #1 oil producer
•
One of the world’s top 5 publicly traded oil companies
•
Most internationally diversified with projects in the Republics of
the former Soviet Union, Eastern Europe and the Middle East
•
Holds up to 2% of world’s output of oil
•
Emerged on Nov. 25th, 1991 from a consolidated venture of 3
production associations – Langepasneftegas, Uraneftegas and
Kogalumneftegas (LUK OIL)
•
Organized into an Open Joint Stock company on Apr. 5th, 1993
Acquisitions
Making History…
• In 1999 Lukoil acquired KomiTEK oil company
• First post privatization corporate merger in Russian oil and gas
industry
• This strengthened Lukoil’s position in the oil sector even
further
• That same year it acquired Saratov petrochemical plant
• In 1999 it acquired oil refineries in Odessa and Bulgaria
• In 2000 moved its operations beyond the Atlantic Ocean
• Acquired Getty Petroleum Marketing Inc.
American corporation controlling petroleum
stations in 13 NE States, covering NY & NJ
• In 2001 attained 60% voting right of the
NORSI OIL – Nizhniy Novgorod Refinery
LUKOIL Production
Growing…Growing…Grown
•
Producing higher volumes of jet and diesel fuel, and are expanding
in the petrochemical section
•
Increasing its refining capacity in both Russia and Internationally
•
Constantly implementing refinery upgrade to meet American and
European Standards
•
Believe Eastern European Markets provide for low cost and retail
sales growth opportunities
•
Natural gas production went up
by 11% & oil refining volume
increased by 18% in the last year
Caspian Exploration
Why, When and Where…
• Over the past year Lukoil has been penetrating the North Caspian
Region:
– Sign of company’s upstream development strategy
– Shift the pressure from worn out fields in Siberia to underdeveloped
fields
• As per World Bank – Caspian will be a key region for most of the
future’s oil production
• In 1997 Lukoil + Atlantic Ritchfield Company
(ARCO, sub of BP) = LUCARCO
Agreement
• Working together on the exploration and
the development of the North Caspian
Region
• Political Union – BP’s down payment for
Russia’s compliance on the war against Iraq
Gazprom and LUKOIL
The Venture…
• In Nov. 2002 two biggest Russia’s gas and oil producers signed a
strategic partnership agreement
• Together will sponsor the exploration and development in the
North Caspian Region
• There are large deposits of gas in the North Caspian Region
• Lukoil is intending to use Gazprom’s pipelines because the tariffs
on those are too high
• Lukoil benefits because it is looking to expand its gas sector
“Keep you friends close, and your enemies even closer”
West Qurna Project
Entering Dangerous Waters
•
In 1997 Lukoil and the Baghdad Oil Ministry signed a production sharing
agreement (PSA) to develop the West Qurna Field
•
Would have brought Lukoil $70 billion worth of oil
•
Lukoil would own one of the biggest oil fields Baghdad has ever offered
•
In December of 2002 Iraq’s ministry terminated the contract
•
As per Baghdad Oil Ministry Lukoil failed to meet its obligations
•
Main point was to develop the field, Lukoil harmed
the Iraqi economy
•
The true reason behind the termination was hidden
Russian Federation – Political
Initial Agenda
• Restore Russia’s international image as a great world power
• Pro-Western stand
• Support following September 11th, 2001
• May 2002 – Signed bilateral strategic arms reduction
agreement with the U.S., and agreed on creation of Russian
NATO Council
Russian Federation – Political
• Implications of Impending War in Iraq
– Positioning: Side with U.S.?
Side With U.S.
Not Side With U.S.
Maintain built-up positive relations
with U.S.
Economic gains from lucrative oil
contracts with Iraq
Improve chances with entrance of
NATO
Implications with EU leaders – France
and Germany
Greater involvement in distribution of
Iraqi oil in the case of a U.S. victory
Hussein’s tactics from Gulf War could
imply rise in Russian oil prices
Might not receive just proportion of
Iraqi oil from the U.S.
•Result: Not side with the U.S.
Side with French-German Entente
Russian Federation – Political
• Political Implications During the War
– U.S. and the coalition forces likely to defeat Saddam
Hussein’s Regime
– U.S. to take lead role of developing post-war Iraqi
government
– Most outside nations, including Russia, believe the United
Nations should assume the lead role
– If U.S. takes lead role, current Russian contracts with Iraq
might not be enforced
Russian Federation – Political
• Political Implications During the War
– April 6, 2003: U.S. House of Representatives passed
an amendment that bars Russia, France, Germany,
and Syria from participating in contracts for Iraq’s
postwar restoration
– Elevated importance of U.N. Security Council
meeting concerning Iraq’s oil revenues
• Oil-for-Food Program
Russian Federation – Political
• Strained Relations
– U.S. accused Russia of providing Iraq with military
equipment
– Russia claimed that U.S. troops shot at a Russian
convoy, which was carrying Russian diplomats
– If U.S. pursues other
“Axis of Evil” countries,
Russian-U.S. long-term
partnership could collapse
Russian Federation – Political
Russian Government’s Future Decisions
• Recognize strong Anti-American and Anti-War sentiment in Russian
people
• Upcoming election might force Kremlin party to play to a receptive
home
• Oil industry’s reliance on political relationships with foreign
countries
• Future Western retaliations to Russian opposition
?
?
Russian Federation - Economy
• Russian Trading System
– Created in 1994 – Energy Index
– Largest Russian Electronic site uniting investment
companies and banks
– Two large movements in history:
• Rise by 1000% in 1996-1997
• Drop by 1000% in 1997-1998
– Based upon results of 1998, 2nd largest fastest rising
index in world
Russian Federation - Economy
Russian Trading System (RTS)
Russian Federation - Economy
Ruble Crisis of 1997
• Initially triggered by Asian Financial Crisis
• Government defaulted on debt and lacked hard currency to pay
out to citizens
• Plan to stabilize economy via currency devaluation failed
• As a result, amount of tangible goods in stores disappeared
rapidly
• Despite problems, LUKOIL pre-tax profit higher then
forecasted profits and production increased
Russian Federation - Economy
Banking System
• Initial stabilization deprived banks of easy profits
• Central banks forced to keep other banks afloat
• Major banks had much capital but could not lend
• Government eager to deal with foreign banks, but they are
wary
• Problems include lack of transparency and legal
framework
Russian Federation - Economy
Corporate Governance
• Rapid privatization led to series of scandals
• Early government attempts to fix issues have not met
with success
• Managers beginning to realize
benefits of Corporate
Governance
• Government attempting new
measures to curb issues
Vladimir Putin meets LUKOIL's President V. Alekperov.
Russian Federation - Economy
Inflation
• Post-Cold War, inflation stabilized at 11% in
1997 (compared to 2500% in 1992)
• Financial collapse led to large increase in
inflation, 6.4% to 84.5% in 1998
• March 2003: Inflation has begin to return to
normal, forecasts expect to be no higher then
12% for 2003
Russian Federation - Economy
• Tax System
– Burdensome and Complicated
– Tax evasion high in the 1990’s
– Tax improvements have begun, but total reform still needed
– Recent changes include:
• Flat Personal Income Tax – 13%
• Maximum Corporate Profit Tax down to 24% from 35%
“But in this world nothing can be said to be certain, except death and taxes, even in Russia”
Russian Federation - Oil
Russia, Thee Oil Producer
• 10% of World’s proven reserves
• 10% of World oil production
– 2001: 348m tons, up from 1999 (305m) &
2000 (323m)
– LUKOIL – 78.3 million tons – 22.5% of
Russian production
• 5 major Russian companies – LUKOIL,
Surgut Holdings, Yukos, Tatneft, & Sidanco
• Lack of funds caused collapse in early 90’s
• Development of new fields has increased
Russian Federation - Oil
Russia, Thee Oil Supplier
• Strong growth has made economy highly dependent
• 2nd largest exporter of oil in 2001 (Saudi Arabia)
• Importance as supplier has put in conflict with OPEC
• Volatile domestic prices caused domestic companies to
slow down
• Recent developments have led to new growth
Russian Federation - Oil
Foreign Direct Investment in the Oil Sector
• Foreign investment has been slow to despite potential
• Deterrents: Political instability, legal framework,
governance, etc.
• Recent steps by government to liberalize foreign entry
have improved relations
• BP Amoco Investment
– 2002: Purchase of 15% more of Sidanko – USD $375m
– 2003: Expected purchase of 50% of Tyumen for USD $6.75
billion
Valuation
Valuation
Any oil company with as large of a production capacity and
world presence as LUKOIL considers two eminent factors:
•Production
–Capacity and recognition of probable oil production
from development projects (Caspian)
•World Oil Prices
–OPEC production and reserves
–Russia’s current and future presence in the oil market
–Effects of the war with Iraq
LUKOIL’s strategic plans for the next 10 years:
• Lower production costs
– Improve efficiencies in existing operations
– Production expansion in lower cost regions (Caspian, Middle East)
• Strengthen Netbacks:
– Lower transportation costs
– Increase proportion of sales in international markets
– Improve quality of crude oil
• Increase Capital Expenditures to facilitate expansion
Capital Expenditures, exploration and investment programs:
Project:
Completion Date:
Investment Amount ($m)
Neftochim burgas AD
2005
$84
Petrotel SA
2008
$86
Russian Federation
2006
$471
Iraq
2004
$495
Caspian Region:
2030
$1,008
Total Expenditures:
“Good Things Come to Those Who Wait”
$2,144
Sales Projections: Sensitivity Analysis
Production:
•Development of the Caspian Region expected to have
largest effect on production
•Expected closing of 5000 unproductive oil wells
•Level of ownership of the license
by Kazakhstan
Best Case Production Projections:
2,000
1,000
08
20
07
20
06
20
05
20
04
20
03
20
02
0
20
• Highest growth rate for
2002-2005 of 5% and
10% for 2005-2008
• Based on successful extraction
and quick extraction of
3.3 billion barrels of extractable
reserves
3,000
01
Caspian Production
4,000
20
• Optimal cost savings
• Will increase production
level by 3% for 2002-2008
Best Case Production
Millions of Barrels
Closing of promised 5000
unproductive oil wells
Years
2001
2002
2003
2004
2005
2006
2007
2008
Overall Production Growth Rate:
2002-2005 = 8%
2005-2008= 13%
Intermediate Case Production Projections:
Intermediate Production
3,000
2,500
2,000
1,500
1,000
500
0
2001
2002
2003
2004
2005
2006
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
Millions of Barrels
Closing of approximately
3,000 unproductive oil
wells
• Moderate cost savings
• Will increase production
level by 1.5% for 20022008.
Caspian Production
• Moderate growth rate
for 2002-2005 of 4% and
7% for 2005-2008
Year
2007
2008
Overall Production Growth Rate:
2002-2005= 5.5%
2005-2008= 8.5%
Worst Case Production Projections:
1,500
2001
1,000
2002
500
2003
2004
0
Year
08
20
07
20
06
20
05
20
04
20
03
20
02
2005
20
• Lower end of projection
growth rate for
2002-2005 of 3% and 4%
for 2005-2008
• Based on slow and low
level of extraction and
higher level of
ownership of the license
by Kazakhstan
2,000
01
Caspian Production:
2,500
20
• No cost savings.
• No contribution to
production level growth
Worst Case Production
Millions of Barrels
Closing of unproductive
wells is either too costly
or unsuccessful
2006
2007
2008
Overall Production Growth Rate:
2002-2005= 3%
2005-2008= 4%
Sales Projections: Sensitivity Analysis
Oil Prices
• World Bank estimates
• Prolonged war and insufficient oil supplies
• Comparison to the results of the Gulf War
Note: “Best Case Prices” refer to optimal prices for world markets, assuming
reduction and later stabilization. Under these assumptions prices are the
lowest of the three scenarios, which in turn are least beneficial for LUKOIL.
“It Ain’t Over Till Its Over”
Best Case World Prices:
(Worst Case Scenario for LUKOIL)
Based on World Bank Estimates assuming:
Best Case Oil Price ($/Barrel)
30
25
20
15
10
5
0
Year
08
20
07
20
06
20
05
20
04
20
20
03
Oil Price
($/Barrel)
02
20
$/Barrel
• Short war with Iraq
• Few subsequent attacks on
coalition forces
• Quick integration of new
representative government
in Iraq
• Increased OPEC production
• Increased growth in nonOPEC suppliers, with
Russian being second largest
world supplier.
• Emergence of North
Caspian oil
Intermediate Case World Prices:
Comparison to the results
of post Gulf War Oil Prices
Intermediate Case Oil Price ($/Barrel)
35.00
30.00
25.00
20.00
15.00
10.00
5.00
0.00
Oil Price
($/Barrel)
20
02
20
03
20
04
20
05
20
06
20
07
20
08
$/Barrel
• OPEC led by Saudis, increased
production to calm oil markets
but lacking reserves to offset
post war non production in
Iraq
• Large Iraqi oil fields will
remain unproductive
• New supplies from West Africa,
Caspian Sea, and Venezuela are
not significant enough to affect
oil prices
• New technologies fail to
increase rate of production as
estimated
Year
Worst Case World Prices:
(Best Case for LUKOIL)
Prolonged War and
insufficient oil supplies
Worst Case Oil Price ($/Barrel)
• Oil stocks remain tight into
2004
30
Oil Price
($/Barrel)
20
10
Year
08
20
07
20
06
20
05
20
04
20
03
02
0
20
• Acts of sabotage and
terrorism reduce oil exports
from the Middle East
40
20
• Scud missiles with chemical
war heads are launched at
coalition forces
$/Barrel
• Iraqi opposition will remain
strong: attacks from Iraqi
forces from Syria
50
Sensitivity Analysis Overview:
– Arrived at most likely scenario for LUKOIL
– Correlated production scenarios to oil price scenarios
Projected Revenue
Sensitivity Analysis
70,000
Best Case
Production
60,000
Intermediate
Level
Production
50,000
Worst Case
Production
40,000
30,000
20,000
10,000
0
Best Case Prices
Intermediate Level Worst Case Prices
Prices
Scenario Analysis Conclusion:
Most Likely Outcome: Intermediate Production and Best
Case World Oil Prices
• Why Intermediate Production:
– The Caspian project will not be as successful as earlier predicted.
– Closing of 5000 unproductive oil wells will not be successful: high
operational and environmental costs
– Number of unproductive oil fields to be closed will equal breakeven
volume
• Decreasing expenses and idle capacity
• Why Best Case World Oil Prices:
–
–
–
–
Lower demand for oil due to recession and slow economic growth
Higher non-OPEC oil production (West Africa and Caspian)
Release of reserves by OPEC to keep prices within target
Past 20 years shown decline in oil prices at the end of war
“History repeats itself”
Most Likely Scenario:
Graphical View of Projected Revenues
Scenario 4: Intermediate Production and Best Case
Prices
45,000
Revenue (in million of USD)
40,000
35,000
30,000
25,000
Revenues:
20,000
15,000
10,000
5,000
0
2002
2003
2004
2005
Year
2006
2007
2008
Cost of Equity: CSFB Model
International Cost of Capital (CSFB) Inputs:
International Cost of Capital (CSFB) Inputs:
A (CV or RTS/ CV of S&P)
-0.439
CV of RTS
0.974
CV of S&P
-2.219
SY (Sovereign Yield)
0.034
Beta of RTSI
0.825
K (Adjustment Factor)
Russian Fed. Rf rate
0.6
0.17
E[r-Rf]
0.307
Brady Bond Yield-Semi-Annual
0.128
Brady Bond Yield-Annual Adj.
0.271
CV of Local Market= Standard Deviation of RTSI/ Mean of RTSI
CV of US Market= Standard Deviation of S&P/ Mean of S&P
International Cost of
Capital:
E[r]= SY+B{E[r-Rf)*A} *K
E[r]= .271+.825{(.307)*(-.439)}
*.6=
20.43%
Cost of Debt
Cost of Debt:
• Credit Spread Rating: BB– BB- rating of 4.13% is average of B+ and BB ratings (4.75%
and 3.5%)
Risk Free Rate: 10.47%
• Risk Free Rate for US 10 year T-bonds = 3.95%
• Risk Free Rate of the Russian GKO Ten Year Bond= 17.0%
• Average of US Risk Free and Russian Risk Free Rate:
10.47%
Cost of Debt= Average Rf + Credit risk spread : 14.61%
Weighted Average Cost of Capital
WACC
Cost of Equity
20.43%
Cost of Debt
14.61%
Market Value of Equity
$10,412,500,000
Market Value of Debt
$71,284,399,127
Market Value of Firm
$81,696,899,127
Equity/Total Firm Value
12.75%
Debt/Total Firm Value
87.25%
Corp tax rate=
24.00%
WACC=(E/V)*re+((D/V)*(rd)*(1-T))
WACC= 12.29%
Cash Flow Analysis
(Free Cash Flows to the Firm)
Net Income
•
•
•
•
•
•
•
Revenue: Based on production minus reserves (9% of annual production) in
Scenario 4
Operating Expenses: 1.5% yearly reduction
SG&A: 15% annual increase due to increased exports
Depreciation, depletion and amortization: 5% historical annual increase
Excise and Export Tariffs: 30% annual increase due to increase in exports
Interest Expense: 15% historical annual increase
Corporate Taxes: Reduced from 35% to 24% in 2002 per government tax
reform.
Capital Expenditures
•
30% annual increase based on projects in progress
Changes in Networking Capital
•
•
•
•
Growth in current assets and liabilities
Annual growth in current assets based on Yukos financial statements
Growth in current liabilities of 21.2% based on historical data
Reduction in networking capital as projects approach completion dates
Free Cash Flows to Firm Analysis:
Major Highlights
• Free cash flows decrease from 2003 due to increase in Capex in shortterm projects
• Revenue from short-term projects will not be realized till 2010
• Revenue from long-term projects (Caspian) will not be realized till 2032
• By discounting annual FCFF by Cost of Capital (11.41%), firm value
equals
•
52,627 million USD.
FCFF Analysis
Net Income
Depreciation, depletion and amortization
Capital Expenditures
Changes in Networking Capital
Free Cash Flows to Firm
2002
2003
2004
2005
2006
2007
2008
17,701
18,168
14,289
13,785
10,835
11,020
10,917
930
977
1,026
1,077
1,131
1,187
1,247
-1,059
-1,482
-1,927
-2,505
-3,256
-4,233
-5,503
-73
-149
-249
-379
-547
-761
-1,034
15,785
15,858
11,585
10,582
6,994
6,361
5,201
0.47%
-26.94%
-8.66%
-33.91%
-9.06%
-18.24%
12,768
8,429
6,939
4,223
3,489
2,628
Growth Rates:
Discounted Cash Flows at Cost of Capital (12.29%):
Value of Firm
14,152
52,627
(in million of USD)
Free Cash Flows to Equity Analysis:
New Items:
•
•
–
Principal Repayments
•
– As projected by LUKOIL,
maintaining current debt ratio (87%)
FCFE
Proceeds from New Debt Issues
Based on maturing debt and current debt ratio
Preferred Dividends
–
As per Russian Federal Law, 10% of net income
2002
2003
2004
2005
2006
2007
2008
17,701
18,168
14,289
13,785
10,835
11,020
10,917
930
977
1,026
1,077
1,131
1,187
1,247
Operating Cash Flows from Operations to Equity
18,631
19,145
15,315
14,862
11,966
12,208
12,163
- Capital Expenditures §
-1,059
-1,482
-1,927
-2,505
-3,256
-4,233
-5,503
- Principal Repayments
478
799
208
424
374
143
143
+ Proceeds from New Debt issues
750
1,254
327
666
587
224
224
- Changes in Networking Capital¥
-73
-149
-249
-379
-547
-761
-1,034
-Preferred Dividends
211
1,770
1,817
1,429
1,379
1,083
1,102
FCFE per year
19,824
19,462
15,792
16,559
14,603
16,200
17,680
Discounted FCFE (Cost of Equity: 20.43%)
16,461
13,419
9,041
7,872
5,765
5,310
4,812
Net Income
+ Depreciation, depletion and Amortization
Value per Share (estimated)
$73.69
Current Price (LUKOY.PK: As of Friday close)
$62.50
Percent Undervalued:
18%
Conclusion and Recommendation:
• The Country:
– Russia will experience a Renaissance, given successful
policy implementation and monitoring
– Russian oil industry expected to become a dominating
force in the world markets
• The Company
– LUKOIL is a lucrative long-term investment
– Maintaining of its market share and strategic alliances,
probable future reserves will equal proven current
profits
------------------------------------------------------------------------What Professor Mei will realize in capital gains if he
invests $1,000,000 is $179,040 + Dividends!!!
“Early Bird Gets the Worm”