THE WALL STREET JOURNAL: ConocoPhillips to Buy Stake in Lukoil: “Meanwhile, the rush for a foot in the Russian door continued on other fronts yesterday as top executives at Royal Dutch/Shell Group met with Russian Prime Minister Mikhail Fradkov during his visit to The Hague.” (ShellNews.net)

By RUSSELL GOLD and GREGORY L. WHITE

Staff Reporters of THE WALL STREET JOURNAL

September 30, 2004; Page A3

ConocoPhillips announced a $2.36 billion (€1.95 billion) strategic alliance with OAO Lukoil, under which Conoco will buy a 7.6% stake in the Russian oil titan and get a share in joint projects. The deal provides Conoco access to Russia's enormous but largely undeveloped oil and natural-gas reserves and opens a possible avenue for it to become the first Western petroleum producer to return to Iraq.

The move, announced yesterday, vaults Conoco ahead of most of its supermajor oil peers, who largely have been unsuccessful in seeking a Russian partner. Under accounting rules, the agreement would contribute to Conoco's proved reserves and production, closely watched measures of an oil company's prospects.

The deal underscores the strong interest in Russia from foreign investors despite fears of a growing Kremlin clampdown on political life and control over the energy industry. For energy producers looking to slake the world's growing thirst for oil, Russia represents one of the few places in the world where large reserves are available to private investors.

But it remains unclear how much say Conoco's large investment actually buys in Lukoil's affairs, and some market observers remain wary. To ensure Conoco's interests are protected even though it has only a minority stake, Lukoil agreed to give the Houston company one seat on the 11-member board and change its corporate charter to require unanimous board approval of top corporate decisions.

Conoco said it plans to raise its stake to 10% by year end and to 20% within two to three years, which would cost about $3 billion at current prices. As Conoco's stake rises, it would get another board seat. Earlier deals have run aground on the issue of management control: In 2001, BP PLC sold its 7% ownership in Lukoil because it said the stake was too small to have an effective voice in company decisions.

Lukoil was Russia's largest crude producer until earlier this year, when OAO Yukos overtook it. Run by Soviet oil-industry veterans, Lukoil was overshadowed in recent years by faster-growing companies such as Yukos, but Lukoil Chief Executive Officer Vagit Alekperov scrupulously maintained close ties to the Kremlin that seem to have paid off. The Kremlin's blessing has been critical ever since Yukos ran afoul of President Vladimir Putin last year, landing founder Mikhail Khodorkovsky in jail and scuttling talks with Exxon Mobil Corp. over a deal.

"We look at it as a unique opportunity, and we have the support of the U.S. and Russian governments," Conoco Chief Executive Officer James Mulva yesterday told a news conference in Moscow. He and Mr. Alekperov met Mr. Putin in southern Russia in July to discuss the deal. "We view the situation," Mr. Mulva says, "as very different from Yukos."

Conoco won an auction yesterday to acquire the Russian government's 7.6% stake in Lukoil for $1.99 billion. Lukoil managers, who own about 20% of Lukoil, said they don't plan to sell their shares as part of the deal.

Analysts were skeptical that Conoco really had secured any control over Lukoil. "It's a little bit of a gamble," says Frederick Lueffer, an oil analyst at Bear Stearns. "Anyone who has taken a minority interest in a Russian oil company has ended up unhappy." Stock traders also were uneasy, sending down Conoco stock by $1.64 to $81.57 at 4 p.m. in composite trading on the New York Stock Exchange. Mr. Mulva insisted the pact gives Conoco enough voice to protect its interests.

The deal also gives Conoco a toehold on Iraq's vast oil fields, improving its chances of someday producing oil there. The deal gives Conoco a 17.5% interest in a 1997 contract granted to a Lukoil-led group to develop Iraq's West Qurna oil field, a major prospect with estimated reserves of as much as 15 billion barrels. The contract was canceled unexpectedly, however, just before the U.S.-led invasion in March 2003. Saddam Hussein-era contracts are being reviewed by Iraqi oil officials.

This has left Lukoil in a tenuous position, but the company has been trying to exert political pressure on the reconstituted Iraqi Ministry of Oil to confirm the validity of its claim.

Mr. Alekperov said he hopes having a U.S. partner will help make the deal stick. If it does, this is a huge opportunity for Conoco and "without Lukoil being there, Conoco would be hard-pressed to get a seat at the table," says Rick Burdick, a partner with the Akin Gump Strauss Hauer & Feld LLP law firm, which advised Lukoil.

Conoco also has agreed to pay $370 million to Lukoil for a 30% stake in a new joint venture to develop reserves in the Timan-Pechora in northern Russia, although the companies will split operational responsibilities equally. Conoco could spend an additional $1.2 billion to $1.5 billion to exploit the field.

Despite nagging questions about management control, Conoco's significant entrance into Russia's large oil and natural-gas fields is seen by many as the latest in a series of blockbuster deals by Mr. Mulva. "Jim Mulva has done a lot of successful deals in this business," says Robin West, chairman of international consultant PFC Energy. "So far his track record in deals is excellent." Since 2000, Mr. Mulva has orchestrated two multibillion acquisitions -- of refiner Tosco Corp. and Arco's Alaska crude-oil assets -- and put together the $15.2 billion merger of Conoco and Phillips Petroleum.

Meanwhile, the rush for a foot in the Russian door continued on other fronts yesterday as top executives at Royal Dutch/Shell Group met with Russian Prime Minister Mikhail Fradkov during his visit to The Hague. Shell's corporate parents are Royal Dutch Petroleum Co., of the Hague and London-based Shell Transport & Trading Co. A Shell spokeswoman said Jeroen van der Veer, Shell's top executive, discussed "growth opportunities" in Russia's energy sector with the prime minister, but declined to elaborate. Shell has focused recently on a possible tie-up with OAO Gazprom, the big Russian natural-gas company. Discussions have taken on new urgency for Shell since Gazprom's announced merger with Russian oil company OAO Rosneft, transforming the company into a colossal state-controlled oil and gas concern. Earlier this month, ChevronTexaco Corp. said it jointly would examine natural-gas export and energy-exploration projects with Gazprom.

--Chip Cummins in London contributed to this article.

Write to Russell Gold at russell.gold@wsj.com

and Gregory L. White at greg.white@wsj.com