No. 1, 2010

LUKOIL-Beopetrol is working to strengthen its position in the Serbian market by raising the quality of service

LUKOIL, a leader in Russia's economy, operates profitably in the East European Baltic nations' fuel market through its LUKOIL Baltija Group of subsidiaries, comprising four companies: LUKOIL Baltija (Lithuania), LUKOIL Baltija R (Latvia), AS LUKOIL Eesti (Estonia), and Teboil (Finland).

LUKOIL's Balkan Frontier

When LUKOIL acquired controlling interest in Serbia's Beopetrol chain of service stations in September 2003, the echoes of the Balkan war had just died, and it was still far from clear what path of development Serbia would follow in the future. One axiom remained unshakable, however: the Balkans always have been and always shall be the crossroads of Europe.

"LUKOIL's strategy is to increase end-user sales of the petroleum products manufactured at its plants, both domestically and abroad. The Company has acquired a number of oil refineries in Europe (in Bulgaria, Romania, and Italy) and is now examining the possibility of purchasing new assets," notes LUKOIL Vice President Vadim Vorobyev. "The former Yugoslav republics, Serbia included, are also of great interest in regard to the development of our retail business."

It seemed as though Serbia's petroleum products retail market was a prize worth winning. In trying to penetrate it, however, LUKOIL encountered a number of problems - economic, legal, and even social.

First of all, the ramifications of Yugoslavia's collapse continued to be felt: a number of open legal problems remained. So long as there was a unified federal state, the Croatian firm INA was responsible for the marketing of petroleum products. Once the country had collapsed, however, the filling stations on the territory of Serbia were nationalized and then privatized, with LUKOIL as their new owner. It was only recently that the Serbian government issued an order calling for the stations to be transferred to LUKOIL in the manner prescribed by law. It is expected that all of the legal issues will be resolved within the next year or two.

Second, the company had to deal with a number of restrictions on the Serbian oil market. It remains closed today: imports of petroleum products equivalent to those produced inside the country are strictly forbidden. The NIS company, which owns two refineries (one in Pancevo and the other in Novi Sad), therefore has complete monopoly over the Serbian market. In 2008, controlling interest in NIS was bought by the Russian company Gazprom Neft, which plans to invest substantial funds in the rebuilding of its new asset. LUKOIL is, however, still forced to buy most of the petroleum products it markets in Serbia from NIS. From its refineries in Eastern Europe, the Company delivers only a limited range of products that are not manufactured inside the country (for example, motor oils and diesel fuel that meet Eurostandards).

"The quality of the petroleum products manufactured in Serbia is not too high, and the retail outlets' markup is not very large; at the same time, the Company's costs are about the same as in Russia and the rest of Europe. But we have experience from breaking into the markets of Bulgaria and Romania before they were members of the European Union, and their economies were distinguished by a high level of government regulation," LUKOIL Vice President Vadim Vorobyev notes. "We hope that Serbia will continue to develop its petroleum products market regardless of whether or not it joins the EU, since liberalization and the introduction of market mechanisms in this field are now the worldwide trend - although this process can of course go rather slowly and not always along the same path as in the other nations of Europe. The experience of the Russian companies acquiring refineries and retail assets in Serbia will, I hope, be of help in developing its market."

Third, the physical condition of Beopetrol's filling stations was a definite problem. Along with a number of fairly well-built highway oases, these included stations that in no way corresponded to the modern understanding of what retail service should be like.

"We've refurbished around 70% of our filling stations (and we have somewhere around 180 of them). The rest are also being refurbished, but there are some stations that have absolutely no business future," says Alexander Panfilov, General Director of LUKOIL-Beopetrol.

 LUKOIL-Beopetrol has something to be proud about: it is no exaggeration that the refurbished service stations under the Russian holding's brand are the most attractive things on Serbia's roads. Well-kept grounds, service islands with state-of-the-art gas pumps, convenience stores with a wide selection of goods, and comfortable cafes are invariable attributes of LUKOIL's updated service stations.

Vector of development

The modernization of LUKOIL-Beopetrol's gas stations made it possible to substantially improve the company's financial situation. "The company was in a state of crisis before we bought it. Prior to 2008, its cash earnings were negative. We've managed to turn the situation around, though, and beginning in 2012, we plan to bring the company stable profits - which should be of interest to LUKOIL's shareholders, the Serbian government, and our employees," says Alexander Panfilov.

The company isn't about to stop there, however. A new plan for strategic development for the period leading up to 2019 has already been drawn up and is waiting for approval in the company's main office. Its leitmotif is preparing for the approaching liberalization of Serbia's petroleum products market.

"After liberalization, I think we'll do quite well with the retail assets we already have," says LUKOIL Vice President Vadim Vorobyev. "Our main goal is to guarantee the high quality of the petroleum products we market. The fuel we produce at our refineries in Burgas, Bulgaria, and Ploesti, Romania, are much higher in quality than the products of Serbian refineries. Of course, we're also looking at expanding our network. It is not going to be on a massive scale, though; more likely, it will focus on different points across the country. We will go primarily for the big cities, Belgrade and Nis in particular. The highways running from the north and east to the country's south and west are also of great interest, of course. The density of traffic on these roadways has always been great, and after their EU-funded reconstruction, transport flows will be even more powerful."

It is expected that the number of new stations will be low: around 40 over the next 5-7 years, but the volume of sales at them should be substantially higher than today's average indicator. By 2015-2017, LUKOIL plans to cross the 500,000-550,000 ton threshold.

In addition, two tank farms have been refurbished and brought back onto line, one on the Danube and one in the heart of Serbia. They are quite conveniently located, and after the market opens up, the company will be able to receive petroleum products from Bulgaria and Romania by means of riverine and railroad transport. Diesel fuel that meets Eurostandards is, incidentally, already being supplied (LUKOIL controls around 60% of the Serbian market for this product). The Company has also become one of the country's main suppliers of fuel gas, with more than 30 dispensing units installed at its filling stations last year.

LUKOIL is also thinking of developing its wholesale trade. Today it sells Eurodiesel to a number of European corporations operating on the Serbian market, including OMV and Hellenic Petroleum. Collaboration with local firms is also being cultivated - with the government-owned company responsible for international and intercity coach service, for example, which owns more than 1,200 buses. LUKOIL-Beopetrol has signed a five-year contract with this company and provides its fleet with fuel not only along the highways but at its depots as well. LUKOIL's Eurodiesel is also marketed through privately-owned filling stations and small local service station networks: there are around 600 such stations in Serbia, out of an overall total of approximately 1,200 fillins stations. Such major potential clients as Serbia's Petrohemija plant are also of great interest to LUKOIL. In the future, deliveries of straight-run gasoline might be made there.

Both the Company's production infrastructure and its employees have to be ready for the arrival of a new era. The LUKOIL-Beopetrol management team has managed to inculcate the corporate principles that govern the personnel of the holding's affiliates in dozens of countries around the world. "The privatization contract contained major social guarantees for our workers, and these benefits were also included in the employees' collective labor agreements," says Alexey Grigoryev, LUKOIL-Beopetrol's Deputy General Director for Human Resources. "We have come to complete mutual understandings with the labor unions - there are seven at our company - and openly and completely inform them of the state of affairs and our real difficulties. As a result, people are beginning to understand that the problems of the workforce are also those of management, and we have to work together to solve them."

In the LUKOIL tradition, of course, LUKOIL-Beopetrol carries out a wide-ranging program of charity work and sponsorship financing. It assists hospitals and children's homes, providing them with substantial funds. Considerable amounts of money were allocated for the construction of the Avala TV tower in Belgrade. The Serbian public has responded warmly to such gestures. The people of this Balkan country have always felt warmly toward Russia, and the centuries of friendship and cooperation between the two nations are remembered today. The attitude toward Russian business is quite positive - yet another major argument for expanding LUKOIL's presence in this complicated but very promising market.