No. 2, 2008

Since 1998, cooperation between the two major oil and gas companies - LUKOIL and ConocoPhillips - has been developing consistently and successfully

The decade of fruitful business cooperation between the two leading transnational companies –LUKOIL and ConocoPhillips – has added considerable strength to their positions on the world oil market and has made a material contribution to development of the Russia-United States energy dialogue.

An alliance of equals

The first steps toward cooperation between LUKOIL and ConocoPhillips were made back in the early 1990s, when the companies held negotiations about setting up a joint venture in Timan-Pechora. The practical implementation of the plans was launched ten years ago, however, in March 1998, when LUKOIL President Vagit Alekperov and Archie Dunham, President of Conoco, signed a Memorandum of Understanding in Washington. In accordance with this document, the Russian party received a 60-percent share in the project and the American party got 40%. At the time, as proof of its firm intentions to be a permanent presence in Russia, in 1998 Conoco bought 15.7% of the shares in JSC Arkhangelskgeologia, to become its joint owner alongside LUKOIL. Negotiations were initiated once more about setting up a joint venture to develop fields on the basis of a Production Sharing Agreement, but the project was shelved owing to the lack of clarity surrounding its legal status at the time.

On September 29, 2004, ConocoPhillips acquired the 7.59% state-owned block of shares in LUKOIL. On the same day, the heads of the companies, Vagit Alekperov and James Malva, announced the creation of a broad-scale strategic alliance – a transaction worth a record $1,988 billion in the history of Russian privatization.

During the subsequent month and a half, ConocoPhillips was able to consolidate 10% of the shares in LUKOIL. Later, in accordance with a Shareholder Agreement concluded between the two parties, by the end of 2006 ConocoPhillips increased its block of shares in LUKOIL to 20%. Don Wallette, President Russia and Caspian, ConocoPhillips, estimates that, as of the end of 2006, the company had already invested over $9 billion in joint ventures and LUKOIL shares.

Commenting subsequently on the transaction, LUKOIL Vice President Leonid Fedun called the cooperation between the two companies “an alliance of equals,” noting the special synergism of the partnership between the two majors: “ConocoPhillips is a leading refiner in the world among privately owned companies, while LUKOIL owns the world’s biggest hydrocarbon reserves.”

The key project

Within the framework of the strategic alliance, on June 30, 2005, LUKOIL and ConocoPhillips set up the joint venture Naryanmarneftegaz for developing hydrocarbons in the Timan-Pechora oil- and gas-bearing province in the northern part of European Russia. This region occupies an important place in the upstream sector development strategy of the two companies. After all, the prospective resources of the joint venture’s oil fields exceed 10 billion barrels.

The ownership interest of ConocoPhillips in the JV stood at 30%. The transaction involving acquisition of this ownership interest amounts to a value of about $500 million.

LUKOIL and ConocoPhillips were to manage the joint venture on a parity basis. The team of top managers included five representatives from each of the parties. The Board of Directors included Stuart Snow, Vice President of ConocoPhillips Russia, while the General Director was the experienced manager Sergey Gnatchenko.

The Executive Vice President of ConocoPhillips for Exploration and Production, Bill Berry, commenting on the event, stressed that LUKOIL held quite a few licenses in the region and extensive experience in producing oil and gas in the inaccessible Arctic regions. He expressed the hope that the partnership would promote the discovery of an important new energy region in Russia.

In turn, First Executive Vice President of LUKOIL Ravil Maganov expressed confidence that the experience of ConocoPhillips of working in the Arctic would effectively supplement the experience of the leading Russian company and would “help develop this region using the latest technologies, with the greatest possible care for the environment.”

As subsequent years showed, the hopes of the top executives were not in vain. Naryanmarneftegaz uses, in implementing its projects, both LUKOIL’s extensive experience in Western Siberia and the highly efficient solutions developed by ConocoPhillips for use in Alaska. For instance, by applying the methods first introduced by ConocoPhillips in Alaska, the joint venture managed to reduce the number of cluster sites from ten to three, thereby doubling the maximum production level. The environmental footprint of the project and the economic indicators of the development also substantially improved. Use of the production technologies applied by the U.S. partner in Alaska in laying the foundations of the oilfield tanks saved Naryanmarneftegaz almost $100 million. Moreover, the JV’s aggregate savings from joint use of the Western Siberia and Alaska technologies amounted, in 2006 alone, to over $500 million.

In 2004, 400,000 tons of oil were produced on the field sectors belonging to the JV, while the 2007 figure was over 600,000 tons. The year 2007 was a decisive one for the alliance’s projects in the north of Timan-Pechora. A unique production base for heavy and viscous oils recovery was created in the Republic of Komi due to the partners efforts. In addition, commissioning of the Yuzhno-Khylchuyuskoye field in 2008 has allowed LUKOIL to initiate direct deliveries of Timan-Pechora crude to the world market. The Yuzhno-Khylchuyuskoye field is one of the biggest in the north of Timan-Pechora and was discovered in 1981. Its proven oil reserves amounted, as of January 1, 2007, to over 500 million barrels.

It is expected that by 2009, the field will yield 7.5 million tons of oil, which will be transported along the Yuzhnoye Khylchuyu – Varandey oil pipeline and then exported through the Varandey terminal with a capacity of 12-16 million tons a year. The JV’s priority objectives in the Timan-Pechora region will be adding up at least 120 million tons of oil to commercial reserves during the period of 2005-2010 and bringing the annual oil production up to 22-23 million tons in 2015. By this time, the JV plans to put in commercial production 31 new fields in the Timan-Pechora province.

Broad geographic scope of cooperation

LUKOIL and ConocoPhillips often consider the opportunities for joint investment in international projects. There is a framework cooperation agreement in effect for exchange of personnel, this allowing the companies to share experience in oil and gas project management.

At the beginning of 2005, LUKOIL and ConocoPhillips initiated a broad exchange of executives to manage administrative and production units in the partners companies. The program involves employees of chief engineer or leading expert rank in three areas: upstream, downstream and finances. In addition, 15 leading ConocoPhillips specialists act as advisors within the LUKOIL headquarters.

The cooperation with the U.S. company has allowed the Russian major to gain a foothold in the American fuel market. In 2004, LUKOIL acquired from ConocoPhillips 308 gasoline filling stations located in New Jersey and Pennsylvania, bringing over time the number of its filling stations in the United States to approximately 2,000.

LUKOIL is also a major producer and supplier of petroleum products to Europe, where the company already has over 2,000 refueling stations. In 2007, LUKOIL purchased from ConocoPhillips 156 gasoline filling stations in Belgium, 49 in Finland, 44 in the Czech Republic, 30 in Hungary, 83 in Poland and 14 in Slovakia. Within two years, LUKOIL will rebrand the network, which is currently operating under the brand name Jet.

LUKOIL Vice President Leonid Fedun expects that the purchase of gasoline filling stations will make it possible to raise the company’s sales of petroleum products by 1.4 million tons a year (by 19%) compared with the projected LUKOIL retail sales abroad in 2006. After completion of the transaction, LUKOIL’s ownership interest will be 4% on the fuel market in the Czech Republic, 3.5% in Slovakia, 8.3% in Belgium, 6% in Poland, 6% in Hungary and 29% in Finland.

“This transaction fully meets the parameters of the Company’s strategy for developing the downstream business sector, in accordance with which LUKOIL plans, in particular, to expand substantially its retail network in the countries of Europe for selling products with increased added value,” LUKOIL President Vagit Alekperov stressed.

In spite of contradictory news from Baghdad, LUKOIL and ConocoPhillips are to continue negotiating with the government of Iraq to confirm LUKOIL’s rights under a contract for developing the Western Kurna field which has been concluded on production sharing terms. Once these rights have been confirmed and all the necessary consents have been obtained from government authorities and parties to the contract, they plan to conclude supplementary agreements envisaging transfer by LUKOIL of its 17.5-percent ownership interest in the existing Production Sharing Agreement contract to ConocoPhillips.

LUKOIL’s plans for the near future also include signing an agreement with Turkmenia on developing three oil and gas blocks on the Caspian Sea shelf in partnership with ConocoPhillips.

As of today, the cooperation between the two majors has become a substantial contribution to development of the Russia-United States energy dialogue. According to ConocoPhillips CEO James J. Mulva, the union with LUKOIL is something much more than a pure financial transaction. It is true partnership that is being consolidated due to a great commonality of goals pursued by ConocoPhillips and LUKOIL and the other shareholders in the company.