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. Last Updated: 07/27/2016

LUKoil Draws Up a Drastic Revamp

With just months to go before the much-anticipated sale of a government stake, LUKoil presented a drastic restructuring plan Monday that could add $500 million a year to its bottom line.

Analysts, however, were skeptical of LUKoil's ability to stick to the ambitious plan, saying real change would probably only become evident in about a decade.

As part of the restructuring, the oil company, Russia's largest, plans to cut costs from $3.50 a barrel to $2.60 to $2.80 a barrel by shutting down 5,000 wells, or 24 percent of those in operation.

While LUKoil's cost structure should shrink, production should not because 30 percent of all wells account for 85 percent of the company's production.

In fact, LUKoil hopes to increase its oil production by 1 percent to 2 percent a year until 2005. After that, the company envisages annual increases of 10 percent to 15 percent until production hits 140 million to 160 million tons a year. Last year, LUKoil pumped about 80 million tons.

If all goes according to plan, the overhaul should boost LUKoil's annual profits by $500 million.

"We are creating the optimal structure so that the government can make money off the sale of our shares," LUKoil vice president Leonid Fedun said at a news conference.

Earlier this month, Deputy Property Minister Alexander Braverman said the government hopes to reap $700 million from the sale. The starting price has yet to be determined.

Fedun said LUKoil also plans to shift sales of crude and finished oil products from the domestic to the export market, with 70 percent of total output being shipped abroad in the form of crude or oil products.

He said the company has subsidized the financial performance of rivals No. 2 Yukos and No. 3 Surgutneftegaz -- and hurt its own -- by keeping a low profile on the export market.

By the end of this year, LUKoil will spin off its main service division, LUKoil-Bureniye, through a listing on the Russian Trading System and a separate agreement with a strategic investor, officials said. Hiving off LUKoil-Bureniye and other noncore assets will cut the company's ranks by 20,000 people. LUKoil currently employs 140,000.

Industry analysts said that while LUKoil's plans look good on paper, its thrust and presentation left a bad taste.

"We were expecting something a bit more serious," said Vladislav Metnyov, an oil analyst with Renaissance Capital.

Despite being the most liquid oil stock on the RTS, LUKoil has earned a not-so-shining reputation among investors. In February, several brokerages downgraded LUKoil's stock after the company announced a weak 2001 financial performance and then held an awkwardly executed conference call that failed to explain why. Even before that, LUKoil had let investors down time and again by failing to publish financial results audited to generally accepted accounting principles in a timely manner. The payment of last year's dividend was also delayed with no immediate explanation.

The restructuring presentation Monday was LUKoil's chance to once again win investors' hearts, but Metnyov said the company failed to make a convincing argument.

While another $500 million in profits would add 23 percent to LUKoil's bottom line, this still would not be enough to catch up with Yukos.

"We are competing with Yukos, and right now they are more successful than we are," Fedun said.

Yukos CEO Mikhail Khodorkovsky greeted the news of LUKoil's restructuring positively, saying the company -- which many industry observers perceive as a Soviet-era throwback -- would now have more in common with sector leaders Yukos and Sibneft.

"They're now with us," Khodorkovsky told Interfax.

LUKoil should emulate its rivals in its drive for efficiency, said Steve Allen, an oil analyst with Troika Dialog.

"They don't need to do something clever here," Allen said. "They just need to do what Sibneft and Yukos have done."

LUKoil is late in sourcing out its service companies and in copying the Western model, where production and retail are dealt with in separate divisions, Metnyov said. Monday's presentation also emphasizes results that will become evident only in 2010, instead of results investors can see this quarter or, at least, this year, he said.

"The longest investment horizon, from the investors' point of view, is three to four years," Metnyov said. "No one wants to put money into LUKoil now and see the return a decade from now."

LUKoil and the government are targeting foreign investors by selling the 5.9 percent state-owned stake on the London Stock Exchange through a Level 3 American Depositary Receipt listing. This listing has been repeatedly delayed and is now planned for the second half of this year.

Allen said LUKoil has a good incentive to follow through on the revamp plans. If LUKoil management fail to implement them, the government's chances of getting a decent price for its remaining 8 percent stake would be low, he said.

"The problem is that you're not going to know next month or the month after that whether or not their plan is working," Allen said.