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. Last Updated: 07/27/2016

Yukos Making LUKoil Look Bad

Yukos' chief financial officer knew the tables had turned for good when rival LUKoil came to him for advice.

"Can you reveal the secret of your low operating costs?" asked a representative from LUKoil Reserve Invest during a Yukos conference call with investors Thursday evening.

"You mean relative to LUKoil?" responded Yukos CFO Bruce Misamore, laughing. Then Misamore turned serious. "We pay a lot of attention to operating cost decreases."

It was no surprise to investors that an investment company affiliated with LUKoil -- Russia's largest oil company in terms of production -- would inquire about the reasons behind the success of No. 2 Yukos.

On the heels of disappointing financials from LUKoil, Yukos on Thursday released financial results, compiled according to Western accounting standards, that beat the market's expectations. While Yukos may be No. 2 in terms of production volumes, it's second to none in terms of profitability.

For the first nine months of 2001, Yukos posted net profits of $2.2 billion, 13 percent more than LUKoil's figure released earlier this month. Operating expenses were the sticking point. While LUKoil's operating expenses increased 16 percent from the second to the third quarter, Yukos' increased a mere 4 percent, which analysts say is in line with inflation.

Yukos saw revenues of $6 billion for the first three quarters of 2001. LUKoil raked in $10.6 billion.

"Yukos management was successful in controlling costs when electricity, tariff and labor costs were rising," said Vladislav Metnyov, an oil analyst with the Renaissance Capital brokerage. "It has a focused investment strategy that produced tangible results."

While Yukos' market capitalization now tops Russia's chart (it barely inched out Gazprom for the No. 1 spot for the first time last year), its limited liquidity seems to be the only obstacle to blue-chip status.

Core shareholders -- which include Yukos CEO Mikhail Khodorkovsky -- hold about 70 percent of all the oil company's shares. This makes for limited trading. To alleviate the situation -- and to pocket their efforts in improving Yukos over the past two years -- the core shareholders have decided to decrease their holding to 51 percent of the company, analysts say.

The first evidence of this became public this week, when a key Yukos shareholder said banks UBS Warburg and Credit Suisse were placing 1 percent of Yukos as Global Depositary Receipts on Thursday and Friday.

While this may take the wind out of Yukos' stock growth in the short term, liquidity -- as well as prices -- should increase in the long term.

"The results show Yukos has better operating efficiency and better margins than LUKoil," said Chris Weafer, head of research at Troika Dialog, in comments reported by Reuters.

At the market's close Thursday, Yukos was up 2.18 percent at $6.55. After six days of pummeling, LUKoil closed up 1.87 percent at $12.56.

LUKoil vice president Leonid Fedun said the operating costs increased because GAAP accounting standards required LUKoil to fully consolidate the costs of three subsidiaries -- LUKoil-Perm, Ritek and Arkhangelskgeoldobycha -- that the company either took over or gained control of in 2001.

"We couldn't explain it right away because we didn't understand it ourselves fully," Fedun told Dow Jones Newswires this week. "We do our planning, day-to-day management and everything else, including dividend payouts, under the Russian accounting system, but [investors] make their valuations of us under the American accounting system."

And although LUKoil officials were at a loss for words during a disastrous conference call with investors last week, Fedun reassured shareholders that he would keep cutting costs and seeking new sources of revenue. To help bring costs under control, Fedun said LUKoil will slash its investment plans and operating costs by up to 30 percent.

Yukos said it would stick to its investment plans unless world crude prices plunged to the $14-$15 per barrel level. If prices stay above that, it expects a production increase of 24 percent this year.

The price of the benchmark Brent crude continued to hover just above $20 per barrel during London trading on Thursday.