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Wednesday, September 29, 2004

THE CONOCO-LUKOIL AGREEMENT: ARE RUSSIAN TROOPS HEADED FOR IRAQ?

As expected, ConocoPhillips completed its purchase of the Russian government's 7.6% stake in Lukoil, for $2 billion. ConocoPhillips is the smallest of the three U.S. super-majors, while Lukoil is Russia's second largest oil and gas producer. Although the Russian stake was technically up for bid, the deal between the two companies has actually been in the works for about 18 months. A group of investors led by David Guggenheim constituted a token second bidder for the stake, but was never in serious contention.

Given the tremendous assets and capacities of the two companies, each side has a great deal to both give and get from the deal. Perhaps least importantly, the companies simultaneously announced the formation of a joint venture -70 percent owned by Lukoil and 30 percent by ConocoPhillips- to develop Russia's northern Timan-Pechora oil region. The region contains estimated recoverable reserves of 10.3 billion barrels. Although the drilling conditions in the region are quite frozen and quite brutal, ConocoPhillips is experienced in producing in the area. Its joint venture with Russian company Arkhangleskgeologia, Polar Lights, has been both a successful producer, and also lauded for its environmental standards. ConocoPhillips says the venture is expected to produce 200,000 barrels of oil per day by 2008.

Furthermore, ConocoPhillips adds almost 10% to its crude reserves assets overnight by purchasing the Russian stake, which will help shore up its value potential. It also gets a strong foothold in the lucrative Russian energy sector, which boasts not only 6% of the world's crude reserves, but also a full 25% of the world's gas reserves.

Lukoil, for its part, gets a last best shot at something it has been after for a long time: the opportunity to develop the gigantic West Qurna oil filed in Iraq. Lukoil had signed an agreement in 1997 with Saddam Hussein to develop the field, but lost the contract in the politics leading up to the most recent Gulf War. While Russia has tried to regain the claim since the CPA took over administration of Iraqi oil contracts, it has been made quite clear that Russia would not have same standing for contracts as U.S. companies or those of coalition allies. Lukoil undoubtedly hopes that ConocoPhillips' stake in its company will increase its chances of getting a piece of West Qurna.

However, ConocoPhillips' purchase of the Lukoil stake in the shadow of the Yukos dismemberment begs the question: what makes ConocoPhillips so sure that it won't lose its $2 billion to a similar state action?

Clearly there have been conversations on the matter at the highest levels, both at the Kremlin, and perhaps the White House as well. Certainly President Putin has given ConocoPhillips assurances that its investment in Lukoil and the Russian energy sector is safe. It knows it needs quickly to install foreign investor confidence in the all-important sector.

But would Lukoil and Putin give these assurances without in turn having some knowledge beforehand that Washington would push the West Qurna deal through? Probably not. And would Washington willing to guarantee the CPA contract without something further in return from the Kremlin? Again, probably not.

There was speculation earlier this year following a report by U.S. global intelligence firm Stratfor, Inc. that Washington had asked Moscow to contribute troops to Iraq. Stratfor reported that Putin was considering the proposal and would likely make a decision around Christmas. Adding fuel to the speculation was Russia's public denial of the report, which in and of itself gave it more credence than stone cold silence would have. Once can quite easily imagine that Russia would request access to Iraqi oil contracts as part of a troops deal. The ConocoPhillips-Lukoil agreement may just be the first steps in a deal to do just that.

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