VIEW FROM VEDOMOSTI: Oil Companies Taking New Approach to Windfall Profits

What do you do when the market price of whatever you're selling doubles and the demand holds steady? That appears to be a tough question for some Russian oilmen these days.

Mikhail Khodorkovsky, chief of the oil company Yukos, Russia's No. 2 by output, scolded managers at a recent board meeting for their inability to reinvest efficiently the company's windfall profits. "We have learned to draw up plans for banks, aimed at getting financing from them, but these projects turned out to be unfit for implementation," Khodorkovsky said.

The distinction Khodorkovsky makes between a plan drawn up for bankers and a realistic plan will hardly surprise an experienced banker or industrial manager. Especially in Russia, the rule is not unlike the Pepsi slogan with a twist: "Ask for more and you'll get what you originally wanted."

After last year's stunning drop in world oil prices and the August 1998 financial debacle, Yukos only planned 1.7 billion rubles of investment in its oil production facilities for this year. Most of the money earned by the company was to go to its creditors. But this year prices went up and Khodorkovsky sees a chance to step up much-needed investment. Next year's plan is to plow 8.3 billion rubles into retooling and expanding production, an almost five-fold increase.

The lack of preparedness for windfall profits aside, all this signifies a major change in Russian oilmens' general outlook. Four years ago, having just acquired the oil companies, the new owners would have spent any extra profits on more palaces near Moscow or in Switzerland, more jets and jeeps.

An oil reporter I met in London recalled lavish receptions thrown by Russian oil companies with buckets of caviar and magnums of the best champagne. "No Western oil company would have even thought of doing that," the reporter told me.

Now milking companies for all they're worth is a bit pass?.

The "oiligarchs" have come to realize they are in this business for keeps and if they do not develop their companies, they will have little to leave to their offspring. It might be the classic transformation of robber barons into responsible capitalists or it might be the fact that last year's crisis reminded the wealthy that power and glory are not forever.

The consulting company McKinsey & Co. in its recent 400-page study of the Russian economy stressed that in the last 10 years oil production in Russia has dropped almost by 50 percent. New fields are being explored too slowly, smaller deposits are being ignored, new technology like hydrofracturing is not being implemented, McKinsey said.

Until recently, all this was indisputable. Now, things are changing, though maybe not as fast as McKinsey would have advised. Both Yukos and Sibneft have recently signed multimillion-dollar deals with the U.S. company Schlumberger, a major supplier of hydrofracturing equipment. Yukos adopted a program to develop small fields. LUKoil, Russia's No. 1 oil company, has long been spinning off construction, transport and maintenance divisions to increase efficiency.

If oil prices do not drop steeply in the next few months, McKinsey's assessment of productivity in the Russian oil sector (30 percent of the U.S. level) may soon become obsolete.

Another necessary factor here, though, is that the government should not tax oilers to death.

Everybody is sick of the oil industry's moaning about taxes. The government thinks it is justified in asking the wealthiest sector of the Russian economy to share its profits with the poor. However, the government should follow the tycoons' lead and give up the idea of overtaxing a hen that lays golden eggs. Any new taxation proposals should be based on how much oil companies reinvest in production. In fact, there is talk in the government already of making at least some of the additional investment deductible.

Huge systems with a lot of inertia, like the Russian oil sector, do not change overnight. The initial post-privatization euphoria is gone - the financial crisis and the unpredictable world market have taken care of that. The owners of big Russian oil companies are no longer new to the business (in 1995, some of them came straight from banking). There is a clear will for improvement both in the management and in the technological side of oil production.

One only has to hope that no stupid moves by the government will destroy that before it starts producing results.

Leonid Bershidsky is the editor of Vedomosti newspaper.