Mazeikiu Nafta head says watershed Yukos deal will succeed

"Technical issues" have delayed a watershed deal to bring Russian oil heavy Yukos into the Mazeikiu Nafta oil complex, Lithuania's largest company, as an equal shareholder with the current strategic investor and operator, the U.S. energy group Williams, to at long last secure long-term crude oil supplies. The deal is now due to be signed in late October. Lithuania's top leaders have received letters from U.S. President George W. Bush and other high-ranking U.S. officials supporting the Yukos deal and even linking it to Lithuania's bid for NATO membership. Mazeikiu Nafta General Director Jim Scheel is in the man best placed to clarify why the deal is so important to the region. Interview by Bryan Bradley.

The Baltic Times: Is the Yukos deal a watershed for Mazeikiu Nafta? What does it solve and what does it not solve?

Jim Scheel: Yes, it's a watershed deal. I think Mazeikiu Nafta as a Lithuanian company with American and Russian investment will be the model of East-West cooperation, an example of how business ought to operate in the energy industry. It will be a very successful agreement between a Russian producer and an international oil company.

The deal is comprehensive. We take comfort from the alignment of interests between the investors - the government, Yukos and Williams. The LUKoil deal did not have that alignment as LUKoil was not interested in being an equity participant.

Yukos, as an equity investor, has every intention to seek dividend payments and the profitability of Mazeikiu Nafta. And because they are putting their money where their mouth is, to use an American saying, we believe they will be the right partner.

In addition, this is the first long-term supply agreement Mazeikiu Nafta has ever had with a Russian producer, and it clearly has strategic benefits for both parties. From Mazeikiu Nafta's perspective it is a stable base-load supply of crude oil that can be complemented with other crude oil supplies. From Yukos' perspective they have a good customer, one they have an economic interest in.

Yukos is increasing production, as are other large Russian oil companies, and they are looking for a stable home for their oil. We provide that, and with a better netback than if they exported all this oil directly into the ARA (Antwerp-Rotterdam-Amsterdam) markets.

They have agreed to supply 400,000 tons a month to our refinery. This is not all of our demand, roughly only two-thirds at current running rates. But we did not want to have all of our demand come from one source. We want diversity of supply.

We will acquire the rest from multiple suppliers. We'll continue to pursue additional crude oil supply opportunities with other companies from Russia, Kazakhstan or elsewhere, to get the best possible price for crude oil and the widest possible diversity of supply.

When we signed the term sheets in Frankfurt, Yukos immediately began to supply us with 300,000 tons of crude a month for the third quarter. As we enter the fourth quarter they are going up to the full 400,000 tons per month. They are honoring the agreement.

Yukos continues to use our Butinge terminal to export crude under the long-term contract they signed with us a year ago. They have been a good partner from that perspective, and I am confident they will be a good partner as we enter this more expansive relationship.

What else do we get out of this? Obviously we are looking for the $75 million equity investment by which Yukos will gain a 26.85 percent stake in Mazeikiu Nafta. We also look forward to receiving a $75 million loan under the agreement from Yukos. Yukos guarantees to supply almost 5 million tons of crude oil a year.

This $150 million, coupled with some of the working capital freed up by the new payment terms established under the agreement, will be used to continue the modernization effort, to finish upgrading so all our fuel meets EU specifications.

And given the new relationship with Yukos, additional funding will not be a problem.

TBT: Failure to complete the agreements with Yukos on schedule has sparked some concern. The situation seems reminiscent of the alliance with LUKoil announced in May 2000, but which then got delayed several times and ultimately collapsed. Is there any difference?

Scheel: Actually, this is quite different. With Yukos we signed not just a general understanding, but definitive term sheets describing the aspects of the deal, which is quite different from where we were with LUKoil. Currently the delays are not in deal-related issues or points of negotiation but just relate to points of law and getting the contracts in a form acceptable to both sides.

Given the complexity of dealing with both equity ownership and crude oil supply, we decided it was in the best interests of this deal not to rush it, but to let the process work, and to give the government adequate time to review the contract, as one of the other major shareholders. So we think closing at the end of October is appropriate.

TBT: But how do you react to rumors that the delay reflects some renegotiation of the deal, possibly even involving other parties?

Scheel: There has been absolutely no renegotiation or bringing other parties into the negotiations. That would be absolutely incorrect.

We met again in London in the last week of August, and we went through the agreements in extraordinary detail with Yukos' lawyers.

All we are dealing with now are detail issues, things like the exact language, precise arrangements for arbitration, etc. These things are important and need to be dealt with, but do not relate to fundamental issues about pricing, supply volumes, payment terms. Those have all been agreed.

TBT: The European Bank for Reconstruction and Development recently said it was ready to financially support Mazeikiu Nafta's modernization once the Yukos deal concluded but first needed a business plan from you. Is there really no business plan in place yet?

Scheel: There is, of course, a very elaborate business plan that was entered into with the government. We have been operating under that for the last couple of years. What the EBRD is interested in receiving is part of the contract documentation that we are working on now.

The issue is not, "Do we know what we are going to build?" or, "Do we know how we are going to operate it?" but how to describe this in the contract. We are walking through each and every item to get a comprehensive business plan that is fully agreed to by Williams, Mazeikiu Nafta, the Lithuanian government and Yukos.

The EBRD is familiar with our capital program, and as we move forward will be one of our primary financing opportunities.

TBT: How will the day-to-day running of Mazeikiu Nafta change after this deal, once Williams and Yukos have equal stakes in the oil complex?

Scheel: It won't. One fundamental premise is that there can only be one manager at Mazeikiu Nafta: Williams. That is a fundamental issue of this deal and it is one that Yukos has agreed upon. It only makes sense. You don't manage a refinery by committee.

TBT: Last October, Lithu-ania's highest court declared as unconstitutional some legislation related to Williams' investment at Mazeikiu Nafta. Resolving the issues related to that ruling has been named as a pre-condition for the Yukos deal. How is that going?

Scheel: Yes, that's going to be a precondition to close. We are working with the government now. And we have a constructive relationship with the government regarding their desire to honor the (1999 privatization) agreements. So this shouldn't be a problem.

I know that Prime Minister Algirdas Brazauskas understands the position of both Williams and Yukos on this issue and will do what is necessary to make sure this does not become a problem that hinders our deal. I do not think the government has any intention of seeing this block our deal in any way.

I am sure that as we move through October the Constitutional Court issue will be resolved in a manner that is acceptable to all parties.

TBT: Mazeikiu Nafta has reported huge losses in recent years. Even with Yukos, can you realistically stop losing money before modernization is completed?

Scheel: Yes, we can be a success. We have continued to lower basic operating costs, and the pricing terms we are going to be getting from Yukos are in line with world pricing. So we are forecasting a modest profit for next year.

This will be contingent on the refining industry in general, but Mazeikiu Nafta has the potential to improve economically, with this agreement, with the improvements we are making to the refinery, with the continued utilization of the Butinge terminal and the throughput through our pipeline system.

But our long-term viability is really tied to efficiency expansion and the yield improvement that will result from the implementation of the modernization plan. So while we will continue to improve current operations, the majority of economic benefits for Mazeikiu Nafta will come in the future. That has always been understood by the investors. It was in the original business plan.

And that will continue to be part of our overall plan: continuous improvement, making the sorts of investments necessary to make Mazeikiu Nafta a world-class refinery, one of the most profitable refineries in Europe. Not Central Europe, not Eastern Europe, not Russia, not Lithuania, but Europe. We have that potential, we have a good piece of equipment, we have a good plan, we have good partners.