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Russia: LUKoil Withdraws From Deal On Baku-Ceyhan Oil Pipeline

Russia's biggest oil company has dropped out of a deal to help build a Caspian pipeline from Azerbaijan, while promising to cut costs and pursue a new restructuring plan. But after months of negotiation, many questions remain about LUKoil's decision to turn down an investment in the U.S.-backed route.

Boston, 1 May 2002 (RFE/RL) -- The Russian oil company LUKoil has rejected a role in the Baku-Ceyhan pipeline project after making a decision based on business rather than politics, Russian analysts say.

Last week, the Moscow investment bank Troika Dialog said Russia's largest oil company "will not now participate in construction" of the U.S.-backed pipeline from the Caspian to Turkey's Mediterranean port. Lukoil still plans to use the pipeline for oil from its offshore investments in Azerbaijan, the bank's analysts said.

LUKoil officials have shown interest in the route through Azerbaijan and Georgia for the past two years, in spite of resistance from the Russian government, which prefers exports through its own territory.

Azerbaijani officials had hoped that LUKoil's participation would guarantee Russia's cooperation rather than opposition, once construction starts later this year. LUKoil owns 10 percent of Azerbaijan's largest offshore project, which is the main source of oil for Baku-Ceyhan.

In recent months, officials of Azerbaijan's state oil company, SOCAR, predicted flatly that LUKoil would join the consortium for the $2.9 billion line. LUKoil said it was awaiting only Russian government approval before going ahead.

In March, SOCAR President Natiq Aliyev said, "There is a verbal agreement that LUKoil will definitely join [Baku- Ceyhan], and that agreement will be confirmed at the end of March or the start of April," the AFX news agency reported. But no agreement was confirmed.

Instead, on 15 April, LUKoil Vice President Dzhevan Cheloyants told a London energy conference, "Our company will participate in the project as a consumer, but will not participate in financing the pipeline's construction," the Prime-Tass news agency said.

It was not immediately clear that the statement was LUKoil's last word. Several days later, the industry newsletter Petroleum Argus cited the remark but also quoted a LUKoil spokesman as saying that it was "too early to make any official decision."

But again at a 22 April conference in Moscow, LUKoil officials failed to include the pipeline in a presentation of a broad restructuring plan. That move may have marked the last chance for an announcement. The Russian government plans to sell a 5.9 percent stake in the company this year.

The decision came less than two weeks after the government suggested that it might accept LUKoil's participation in Baku-Ceyhan. LUKoil's reversal seems sure to create further confusion about political motives in the Caspian plan.

Speaking on 10 April in Baku, Deputy Prime Minister Viktor Khristenko echoed previous Russian criticisms of Baku-Ceyhan, saying that it was not "economically feasible." But he also refused to rule out a role for LUKoil, saying, "We cannot seriously say that the state is able to form shareholders' position on a particular project."

The analysts at Troika Dialog argued that LUKoil's decision was for purely business reasons. In a research note last week, they said, "Despite some media claims that the decision was taken under pressure from the Russian government, we believe that LUKoil dropped the proposal mainly on economic grounds. The economics of the project are indeed poor, given the persistent uncertainty regarding oil supplies for the 1 million-barrel-per-day pipeline, and expected return on investment is a mere 12 percent."

But the annual return estimate is considerably lower than those cited by either SOCAR or the British oil company BP, which is leading the pipeline consortium. It is also less than one cited by LUKoil's Cheloyants, only four months ago.

Speaking at a St. Petersburg press conference on 14 December, Cheloyants cited a BP study estimating that the pipeline project's profitability had actually risen from 16 percent to about 24 percent. He also confirmed LUKoil's interest in the project, Interfax reported. Last month, SOCAR Vice President Aliyev said the return would be 15 to 25 percent.

The reason for the difference in the figures is unclear. But LUKoil's participation in Baku-Ceyhan might not have been out of line with its other investments, even if the lower estimates proved true. At its presentation last week, LUKoil said its company-wide return on assets for 2001 was 12.9 percent. On services, it was only 4.5 percent.

Whatever doubts have developed for LUKoil, the promised returns on Baku-Ceyhan have been high enough to attract Western oil companies including BP, Norway's Statoil, U.S.-based Unocal, and ENI of Italy. BP officials in Baku, London and Washington did not respond to requests for comment on the discrepancy in the profit estimates.

SOCAR officials say the project will not be affected by the LUKoil decision. An official told Azerbaijan's Media-Press agency, "We have repeatedly stated the economic attractiveness of the project. The existing number of sponsors already makes the project balanced and quite feasible. Unwillingness to participate in the project is a personal matter for LUKoil." The official repeated that the rate of return would be 25 percent.

Last week, LUKoil said it will gradually sell off its service businesses, cut costs and shut down 5,000 marginal wells to improve its performance and help the government's stock sale. Analysts were highly critical of LUKoil in February, when the company reported higher costs and falling earnings in the third quarter of last year.

The company has promised to focus on more profitable activities like exports of refined products and investments in foreign refineries. The pipeline may have seemed a poor fit for the restructuring plan.

But LUKoil has said little about its reasons for dropping Baku-Ceyhan after many months of negotiating a deal. One analyst, who spoke on condition of anonymity, suggested that LUKoil had hoped for concessions on other unrelated deals with Azerbaijan. But there has been no explanation of why estimates on the pipeline's profitability have varied so widely in the past four months.

Whether LUKoil's decision was driven by business, politics or both, it is unlikely to end the questions about Russia's policy toward the Baku-Ceyhan project and the pressures on the Caspian route.