Extended_Essay_Business

{draw:frame} {draw:frame} {draw:frame} {draw:g} Table of Contents Introduction ConocoPhillips in Russia With the fall of the communist regime ofRussia in the early 90’s the doors to Russia’s resources were opened for foreign investors. ConocoPhillips was one of the first American Oil companies to come to Russia and have been active in Russia since the creation on Polar lights Company in 1992 (a joint venture between ConocoPhillips (50%) and Rosneft (50%)). Since within Russia ConocoPhillips took an aggressive role to obtain some of Russia’s oil market share, and in 2004 to 2005 purchased a minority of the shares of Lukoil. ConocoPhillips and Lukoil On September 9th 2004, ConocoPhillips started its investment of 7.5 billion dollars into Lukoil that by the end of 2005 was and is 20% of the company. This was an idea of both companies - for Conoco as a growth strategy and to have influence in the Russian Market, and for Lukoil to obtain western technology, practices and capital to make Lukoil more efficient. Definitions Joint Venture A joint Venture is an entity formed between two or more parties to undertake economic activity together. The parties agree to create a new entity by both contributing equity, and they then share in the revenues, expenses, and control of the enterprise. Growth Strategy A growth Strategy is a strategy based on investing in companies that are growing faster than others in the same industry, with the goal of generating capital gains rather than dividends. Research Proposal Question Was the joint venture between ConocoPhillips and Lukoil been as a growth strategy for ConocoPhillips, the most advantageous' Rationale The question is appealing because before Conoco and Phillips 66 merged, Conoco was present in Russia since the opening of the Russian Market over 16 years ago. They had many investment and joint ventures with Russian companies mostly Lukoil, but 5 years ago they purchased a total of over 20 percent of Lukoil, as the largest US investment in Russia yet. This question will allow us to see the impact of global economic down turn, and the in depth outcome of Russia’s crisis on foreign investors. Including what the competitors have done, and what other investments ConocoPhillips could ventured into, and what would other options out comes be. Areas of the syllabus to be covered I will be drawing on various components of finance, both internal and external to each company. I will examine the financial market in Russia and America, the workings of the stock exchange and a method of predicting the success of a large business. Decision making theory will be used to help evaluate the growth of ConocoPhillips and the value of their investment Possible sources of information Annual Reports, economics texts, ConocoPhillips and Lukoil sites, the Chief Executive Officer (CEO) at the ConocoPhillips, Board members of Lukoil, President of Lukoil and Chairman of the Board of Directors at Lukoil, IBBM Text Boook Organizations and Individuals to be approached Annual reports, CEO’s at both ConocoPhillips and Lukoil, the directors at both ConocoPhillips and Lukoil Anticipated difficulties Difficulties will not be in collecting data from ConocoPhillips and Lukoil. But will be difficult to create data for Russia segment of ConocoPhillips. It will not be difficult to find the opinions of the executives from both sides of the joint venture. It will be hard to find other options not taken by ConocoPhillips and also outside information about other foreign investor in Russia. The Russian Gas and Oil market Russia Russia is the World’s second largest oil producer. The oil industry also has strong political influences coming from the Kremlin; this can be seen in the controversial division of Russia’s largest oil company Yukos. Russia though its vast oil supply has been hardly exploited by foreign firms because of its relatively recent arrival to an investment position due to the fall of communism. Though the volatile backdrop ConocoPhillips made the biggest investment ever by a U.S. company in Russia with its 20% stake in Lukoil. Why Lukoil' Given the vast supply of oil and gas in Russia ConocoPhillips decided to create a joint alliance with Lukoil, but was that the best company choose' ConocoPhillips was looking to make a presents in Russia and believed that through a company it could obtain the natural resources (reserves) needed for growth. In 2004 ConocoPhillips had choice on which companies to invest in. Because many of the Russian oil companies function similarly a PEST analysis of them should be relatively similar so creating a PEST analysis for just investing in Russia is valuable. PEST Analysis of Russian Oil Market: Political During the years prior and after the investment the political struggles between the government and the companies have always been difficult. It is also important to understand that in 2007 with the oil price at $80 the Russian government gets all the taxes it needs but once the oil price drops to half of the that at $36 dollars it does not have taxes coming in and it taxes oil heavily before it gets to the profit stage. This can ultimately make many fields in Russia completely non-profitable for the present time and can cause Russian company’s to lose positive cash flow. It is also important to look at the political problems in a grand scheme because, like Venezuela, Russia could decide to suspend foreign investment in Russia. The political problems could be seen also in the investment in to state owned companies such as Gazprom. In 1991 Gazprom put an offer on the table for foreign investors named “Shtokmahn” it is one of the biggest natural gas fields. After over 16 years of negotiations over the field between Russia and foreign investors it announced that the joint venture with foreign companies would be discontinued. It can be seen that working in Russia for an oil company can been a double edged sword because of its vast amounts of economical possibilities but its volatile political set up can make the investment a dangerous option. Economical The economics of Russia are much like its politics it can be going very well and then a sudden dip in the oil price and it is a unprofitable location. The Russian economy is the 8th largest in the world and is firmly backed by the oil industry this allow ConocoPhillips with more oil reserves than money and resources to acquire them. Having a economy that that will allow ConocoPhillips with technically the ability to invest as much as they want into it is a great contribution to Russia. Though it has such a large oil economy there are of course many obstacles to go over before being able to acquire their natural resources. This is a very effective graph to show Russia’s economy. {draw:frame} It can be seen in the chart above that the Gross Domestic Product of Russia has grown since the 1998 Financial Crisis when the Ruble went into extreme inflation. This can been seen that it is good to invest in Russia because of the increase in the economies size. Though we see in 2008 the dip in the Russian Economy due to the global financial crisis ConocoPhillips would not only not know about this because it’s in the future but it effected every Russian oil companies value on the stock exchange and is not limited to only Russia and their oil industry. We can also see the same results in the Russia Stock Exchange. {draw:frame} It can be seen in the chart above that from 2004 and 2005 when ConocoPhillips gained its 20% stake in Lukoil that the Russian Stock market was going up. Though the shares of Lukoil was bough on LSE (London Stock Exchange) it is also on the RTS (Russia Stock Exchange) and its profit and loses reflect much more that of the RTS. It can also be seen in the chart above that at the time from 2000 to 2008 that the Russian market was growing at a steady rate, which is good for ConocoPhillips investment in Russia. It is also interesting to see that the price at which the RTS was at in 2004 to 2005 is nearly the same value it was in the lowest time in 2009 that shows that though the Economic Crisis and its extreme impact on the Russian Economy it is worth a similar value at times of crisis as it was in 2004. So though there was no return on a 2004 investment there was no lose. This could be seen as both positive and negative, because though the initial investment wont be worth as much they have opened the door to more Russian investments and are able to make deals at lower price because Russia will be looking for foreign investors during an economic down turn. Social Technological The reason that many of the Russian oil companies like Lukoil and TNK look to western companies to invest in their companies is the technology that companies like ConocoPhillips bring. Russia has 6% of the world’s oil and the predictions of how much oil they actually have kept going up and up around the time of In 2004 studies by a Dallas based firmed showed that Russia had up to 100 billion barrels more oil than predicted in 2001. The problem though for Russia was in these fields was what was sitting on top of the oil, which was their technology. Western Companies have been working in conditions much worse than the Western Siberian plains of Russia and were producing much more effectively. In 2001 the Russian firms were extracting around 45% of the oil within a field and anything past that was not cost effective but by 2005 the field were 50% more effective at extracting the oil and were producing at a 50% more effective rate. "The biggest thing is the [new] technology being deployed in western Siberia. The results are beginning to show," says Martin Wiewiorowski, senior vice-president of DeGolyer & MacNaughton in Moscow. It can be seen that from experts like DeGolyer & MacNaughton that the production of oil in Russia could go from 6 million barrels a day in 2004 to 10 million by 2012 because of new technology from the west such as horizontal wells and computerized reservoir management systems. Lehman Brothers Report on Russia In June 2003 Grant Porter Vice Chairman of Lehman Brothers made a report named U.S. –Russian Corporate Partnerships in Russia and Abroad – Quid Pro Quo. In this report he had these findings: Careful Partner Selection Yields a Win-Win Situation From a U.S. Perspective Attractive investment opportunities abiding by ROACE criteria Long-term production growth supported by extensive reserves A significant service sector with scope for outsourcing From a Russian Perspective Access to lower-cost capital markets Access to a skills supporting oil production and longer term EOR plays The capital markets “Halo effect” from partnerships with U.S. Majors Conclusion for Russia Once ConocoPhillips looks at a PEST analysis of investing in a Russian oil company like they did in the years prior to 2004 they can see many reasons why they should shy away from investment, but the shear size of the Russian oil reserves and the need for social connections they decided to gain a stake in a Russian oil company like British Petroleum did with TNK. Which Russian Oil Company to Invest In' Overview In Russia there are many oil companies given the size of the industry. In Russia there a few main companies with a relative size of Lukoil that ConocoPhillips could have invested into. The list of potential Russian companies is as follows: Gazprom, Rosneft, Novatek, BP-TNK, Tatneft, Surgutneftgas. National Oil Companies Throughout the World 82% of oil and gas reserves are held by NOCs(National Oil Companies). These oil companies are state owned and do not let foreign business invest in them in the most part. In recent years we can see a shift in the National Oil Companies strategies. Given that the non state owned companies are working at a rate the same as the national ones, accounting for 48% of the global production of oil, many State or National companies are looking for foreign opportunities, investment, technology, and help. Given the privatization of the oil industry in Russia started in 1992 we see many companies that are private still acting like state owned. As of now Russian legislation says that no foreign company can have over 20% stake in the companies we will believe it possible for ConocoPhillips to invest in many of these. Gazprom and Rosneft are both companies that are owned by Russia and controlled by them this would most likely cause more problems for ConocoPhillips in the future. Non-NOC The other companies in Russia that could be invested in by ConocoPhillips that are not state owned in 2004 were Lukoil, BP-TNK, Tatneft, Novatekand Surgutneftgas. It is assumed that these would be the likely choice by ConocoPhillips because the National companies would most likely not allow a 20% foreign investment in their countries two biggest companies. Appraising Given that ConocoPhillips has six possible companies to invest in we can use many techniques to tell which one would have been the best investment. Net Cash Flow The next section on this paper is on how ConocoPhillips will choose out of the six large Russian firms. Net Cash Flow will be used to show how much each company will make ConocoPhillips on a yearly basis along with Average Rate of Return to show the percentage of profit made on an annual basis. Lukoil – Russia’s largest oil producer. Conoco paid 7.5 billion dollars for a 20% in 2005 which is {draw:frame} {draw:frame} shares ($45 was the mean value of share while ConocoPhillips acquired its 20% stake) this means they have 167 million shares in Lukoil. {draw:frame} Give the data that means their investment now in Lukoil has gone from 7,500,000,000 dollars to {draw:frame} {draw:frame} , where $59 is the current price as of 2010, which equals 9.853 billion dollars which means they have gained a profit of 2.353 billion dollars over 5 years. This means that they have made a yearly average of 470 million. This can be seen as a percentage of original investment by showing {draw:frame} {draw:frame} which is 6.2% earnings on investment per year. Gazprom- Russia’s state controlled company, consist of oil and gas production, 80 percent in natural gas production. It has a market capital as of January 2010 of 149.9 billion. In the time that ConocoPhillips was acquiring Lukoil stock the Gazprom stock hovered around $14. {draw:frame} With its number of shares at 5.92 billion and stock price at $14 the market capital would be roughly 82.8 billion dollars. If ConocoPhillips were to buy 20% of the shares of Gazprom they would be investing 16.4 billion dollars which more than double the investment of Lukoil. With this they would currently have 29.8 billion dollars making their investment’s profit 13.4 billion dollars. Over 5 years they would have made 2.68 billion per year giving them a 16% earnings of investment per year. Rosneft- State owned and controlled company; therefore it was not traded on the RTS until 2009. Rosneft is the national oil company and has given off only a small part of their company to be traded. This makes it impossible to judge how well they will have done compared to the other Russian oil companies. Surgutneftgas- One of Russia major oil and gas producers. It is seen as the least transparent of the publicly traded companies, which my analysts see as a cover to hide the Kremlins control of it. {draw:frame} Estimated worth of 38 billion dollars in 2005. This means that if ConocoPhillips wanted 20% it would cost 7.6 billion dollars, which is nearly the same as Lukoil. In 2005 the average stock price was 40 dollars, which would make the ConocoPhillips investment at 190 million shares. As of 1st of January 2010 the price of their stock was $9.28. This means they would have {draw:frame} {draw:frame} , which is 1.763 billion dollars, which would make a loss of 5.837 billion dollars. This would mean that the percent earnings on this investment per year would be {draw:frame} {draw:frame} , -15.3%; and yearly loss of 1.167 billions dollars. Tatneft- Is Russia’s sixth largest oil company. Publicly trade company. It is largely influence by the Tatarstan government who has a 37% stake within the company’s shares. Their shares are also traded so thinly that it is impossible to compare with the others. Until 2009 with the BP purchase of 1 billion dollars worth of shares Tatneft were not sold to the large foreign oil companies. Novatek- In 2006 total look to Novatek to invest their money in. Novatek is Russia’s largest private natural gas producer. Today Novatek is net market value is 24 billion dollars. Since 2005 the market value has multiplied by 5 times. It started 2005 worth 1 dollar on the RTS and now the shares are worth 5.50 each. This can be seen in the graph below: {draw:frame} This means that if ConocoPhillips wanted to and had the opportunity to in 2005 to invest into Novatek they would need to spend 960 million dollars. By January 2010 their investment would be worth 4.8 billion dollars. This would over a five-year period give them a profit of 3.84 billion dollars and a average net cash flow of 768 million per year. Conoco would also have a average rate of return of 80%. Analysis This a chart of possible options of investments for ConocoPhillips from 2005 to 2010 in Dollars It can be seen that there were a few options for ConocoPhillips to take into consideration as of 2004-2005. Though they did not have the information to how the market would go in the years we can see that the best option financially was NovaTek. Even though Novatek is the best option financially it would not be possible for ConocoPhillips to invest into them when they came into the market this can be seen in Total negotiations that failed with Novatek in 2005. Also Novatek was not the type of company that ConocoPhillips was looking for, they needed a company that had large reserved of both oil and gas which Novatek could not provide. Also Novatek with its recent arrival into the stock market ConocoPhillips had no prior information into how it would act with market change. Novatek was also in market capital smaller than the company they were looking for with in 2005 a market capital of 19 billion dollars when Lukoil had a market value of 150 billion dollars The next most viable option for investing money into was Gazprom with a Average rate of return of 16%. It can be seen that the initial investment of 16.4 billion dollars is more than twice that of Lukoil. With a larger investment need the more risk ConocoPhillips is making with it. It is also a Nationally owned oil company which might cause more problems for ConocoPhillips because a difference in objectives. A state owned oil company has different objectives than a private one because a state owned one will look for more than just profit generally and will look for security of the state. It is also important to note the Kremlin’s position on a foreign company seizing 20% of its largest company. Gazprom is Russia’s largest gas producer and the chance that the government would allow a foreign company to have such a large stake in it is next to impossible. It is easily seen that Surgutneftgas would be the worst choice for ConocoPhillips to invest in. Before the poor share performance Surgutneftgas also has problems with transparency. It is a company that exploits Russia’s beneficiary holding laws. This is when a holding company that own part of the company does not have to announce their owners. This leaves almost 20% of the company controlled by unknown forces, which could cause problems for ConocoPhillips’s security of their investment. In addition, to the structural problems of Surgutneftgas it is also the worst performer out of the collection losing over a billion dollars a year. “We were looking at the big companies, they bring us security and resources worth investing into. In Russia there really is just a handful of viable companies to invest this much into. I would say Gazprom, Rosneft, Yukos (until 2003), and Lukoil,” says the ConocoPhillips Russia President. Rosneft because of its tight government control was also unable to be invested into because they have never floated enough of their company to show their true value and profit. This is also similar with Tatneft that has never floated and is heavily influenced by the Tatar leaders. After an investigation into why ConocoPhillips would invest in Russia, and their opportunities by elimination the only possible company that ConocoPhillips could invest in was and is Lukoil. Lukoil though its relatively small earnings compared to Surgutneftgas and Gazprom has out performed RTS and has proven to be a good decision to invest in and has had a 6.2% average rate of return even though the economic crisis of 2008 and 2009. Through investigation I believe it is evident that the best decision that ConocoPhillips could of made given the data from 1992 to 2010 was the one they made, which was to invest 7.5 billion dollars into Lukoil. Bibliography Hall, Dave, Rob Jones, and Carlo Raffo. Business studies. 3rd Edition. Essex: Longman, 2004. (156) (568-672). Print. "Financial Review, Lukoil Investment." Conocophillips_ Annual Report 2007_. 2007. Houston: 2007. Print. Porter, Grant. "U.S. -Russian Corporate Partnerships in Russia and Abroad -Quid Pro Quo." Lehman Brothers. (2003): all. Print. "Novatek, Lukoil." RTS Exchange. 10/01/2010. "Russian Trading System" , Web. 21 Jan 2010. http://www.rts.ru/en/. "Gazprom, Surgutneftgas." _Yahoo _Finance . 10/01/2010. "Yahoo Inc", Web. 10 Jan 2010. http://finance.yahoo.com/.