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. Last Updated: 07/27/2016

THE ANALYST: Idiosyncratic Surgutneftegaz Does Business Its Own Way

If crude oil had a personality, then Surgutneftegaz would be eccentricity.

By its words and actions this company is a confusing puzzle; it gives conflicting signals and leaves analysts in a quandary to guess its next move. On the one hand Surgutneftegaz is one of Russia's best-run corporations, but shareholders are worried sick as to whether their shares will be devalued by another dilution. The company has given foreign investors an ADR program to widen and diversify its shareholder base, yet frowns upon its own workers who sell their shares to outsiders. Management has boosted liquidity of Surgutneftegaz's stock, ostensibly to maximize value when the day comes to raise equity capital, yet it issues shares on the illiquid domestic market and buys them back with its own resources. This is definitely a company that likes to do things its own way.

But we should set the record straight immediately: Eccentricity often arises out of excellence. Those who are the best in their profession take pride in "doing it differently" from the other guy. More often than not they don't even want to be associated with these "other guys."

No description of Surgutneftegaz could be more precise. By sticking to the basics -- investing in its core assets, improving technology, and not least of all, paying its taxes -- the company has managed to become one of the most profitable in the sector, while at the same time neglecting transparency and to some extent shareholder value.

There are oil companies in Russia with more reserves, more qualitative reserves, and better downstream operations, but none of them can out-manage Surgutneftegaz. The company concentrates its financial resources on its existing assets base, maintains tight controls over its operations, and keeps debt off its balance sheet. Not a ruble is disregarded in Surgut.

In terms of expansion, Surgutneftegaz has opted to be a passive observer. In one of his rare interviews, company president Vladimir Bogdanov, who has been aptly dubbed the "Surgut Recluse," said oil companies of all sizes can survive on world markets, and world markets have proven this.

Surgutneftegaz truly is a loner; managers are confident that they can get by just fine with a minimum of outside help. The company has declined to create any joint ventures, referring to them as "pointless," and Bogdanov regards the production-sharing law primarily as an effective means to tap difficult-to-exploit reserves without foreign investment. Management has even balked at the idea of a reserves audit: Why should Surgutneftegaz waste the money on one when the most important investor -- the company itself -- is well aware of how much black gold it owns in the ground?

The result is a formidable sense of mystery about what really goes on in Surgut. One gets the feeling that Surgutneftegaz, being quite xenophobic (this writer was threatened with expulsion from the city five years ago), dreads the loss of control more than it fears crude for $10 per barrel. But this inclination to be a loner, to be "investor-indifferent," has given the company its fair share of headaches.

You reap what you sow. In St. Petersburg and the surrounding Leningrad region, distribution subsidiaries of Surgut Holding (the company that owns a controlling stake in Surgutneftegaz) have carried on like a band of renegades, bedeviling Bogdanov and Co. with a host of legal problems. And if there's any truth in Interior Ministry estimates -- that up to 80 percent of St. Petersburg's retail petrol market is controlled by the mob -- then Surgut oil barons are in for a prolonged, expensive battle.

Financially, the company can perform like few others. Pretax profits over the past two years were roughly flat at $840 million; the company has taken advantage of investment-driven tax benefits and its huge export market -- 65 percent of its crude was sent abroad.

Naturally, things are taking a rough turn this year. Twelve-dollar-per-barrel oil will separate the pros from the peons among Russia's 11 oil companies. Instead of relying on cash-heavy exports for profit, managers will have to rely on finer financial legerdemain to squeeze out a profit -- slashing costs. Fat social commitments will be forced to diet, and companies with over-employment (i.e., just about all of them) will have to readjust their socialist mindset. Chances are many companies will refuse to carry out any austerity measures.

Fine; in any event they will survive. This is a country of survivors. But if Russian crude producers are serious about competing with Western majors for the big international projects, they're going to have to learn about making respectable margins during tough times. As of now, there are two companies that can do this in Russia (as long as it remains a purely upstream company, Tatneft's potential will be limited): LUKoil and the Hermit of Hydrocarbons -- Surgutneftegaz.

Gary Peach is the editor of the weekly newsletter Capital Markets Russia.