“The Mother of All Oil Tax Breaks” Silk Road Investor

By Travis Johnson, Stock Gumshoe, June 30, 2008

We’ve run across Yiannis Mostrous and his Silk Road Investor a few times before — and one of the companies he’s teasing us about today I’ve even written about before. But there’s some new stuff here, so perhaps it’s worth a look.

Silk Road Investor is one of many newsletters that focus on Asia writ large — from Russia to Australia and everything in between or nearby, apparently.

The big point of his teaser ad this time is that Russia is slashing tax rates for oil companies — although Russia is producing a huge amount of the world’s oil, much of their production is in decline, so perhaps they’re hoping to spur some more investment. This tax cut will, according to Yiannis, save this oil company about $1.30 a barrel at first.

And he says they have 16 billion barrels of reserves, so that would certainly end up amounting to a fair chunk of change, over time.

This may be starting to sound familiar to you … he tells us that the company is currently valued, based on their reserves, at $5.33 per barrel of reserves (the headline shouts, “How to Buy Oil for Under $6 a Barrel”).

So, yes, we have seen this one before — it’s Lukoil (LUKOY for the official ADR on the pink sheets). And it has had a very nice run since I wrote about it in August — of course, back then oil was at half the price it is now, and then the tease was that you could buy this company for “$3.60 per barrel.”

It’s up about 30% or so since then, so it’s dramatically underperforming the rise in oil prices, as are most oil companies, but it is doing well.

And Russia is, according to everything I’ve read, really reforming its tax scheme slightly for oil companies starting in 2009. They’re essentially raising the exemption — so whereas now they pay taxes only on the price they get for their oil above $9 a barrel, in 2009 the exempt “tax free” portion of the barrel of oil will be $15, and they’re also extending and slightly revamping some of the “tax holidays” that they give for new capital-intensive oil exploration and startup production, particularly in some focused areas of the country.

It seems like people think that this is important, but not necessarily revolutionary or unexpected — Russia fairly desperately needs to invest heavily in new exploration to increase production, and it’s a little harder for them to convince Western companies to invest, right now. I don’t blame them — Shell’s experience with Sakhalin and BP’s experience with TNK, among many other situations, have everyone a bit nervous about dipping their toes in … they’re still doing it, because almost all oil companies are desperate to book mor reserves, but they’re nervous, thinking back to what happened when they last invested in Russia — Western investment that came ten or twenty years ago, when Russia was weak and needy, is coming back to bite them in the arse as Putin’s government has essentially forced their way in and nationalized projects.

But anyway, Russia sorely needs its oil majors to reinvest, so it’s cutting their taxes a bit and trying to encourage them — Lukoil has said that the new law might mean 10% more production over time, I don’t know whether them meant just for themselves or for the while industry, but odds are it would be pretty proportional amongst the majors, on average. I’ve seen analysts noting that this might add as much as 5 or 6% to earnings next year, so it’s significant, but this was talked about pretty frequently starting in March and it was passed in May, so I don’t imagine there are serious Russian oil investors who don’t already know all about it — it’s not like LUKOY is going to double by next week because of this tax cut, in my opinion, and I imagine the price of oil will make dramatically more difference than this tax break, much as Lukoil probably appreciates it.

It strikes me that fear of investing in a private Russian oil behemoth is probably keeping these shares down more than the promise of favorable tax treatment is helping them rise, but that’s just my perspective. I don’t have a markedly different opinion about investing in this sector in Russian than I did back then (you can read that August writeup here), but in the interim I have invested some money in the former Soviet Union through a closed end fund listed in Sweden, so I’ve allowed the overall promise of the growing Russian economy to convince me to shelve some of my political qualms.

Oil disputes and increasingly centralized control of natural resources industries have not disappeared in Russia, as you can see from any article about the ongoing dispute between TNK and BP (the fund I’m invested in does own shares of TNK, FYI), so this remains an investment that’s not for the fearful, but it is certainly the biggest oil company in Russia that’s not controlled (at least, ownership-wise) by the government, and they do have a close relationship with ConocoPhilips and a significant presence outside of Russia as well (including in Iran). And if it were in Texas, it would definitely be really, really cheap — In Russia, that’s up for debate.

But if this were just another look at Lukoil, I’d be just as bored as you are right now — no, Yiannis threw a couple other logs on the fire for us, too, in the way of interesting lil’ investment teaser ideas for us to review.

So what are they, you ask with bated breath?

Number one:

“Levi Strauss’ sure-fire secret for getting rich in a gold rush – When the largest country in the world (with the second largest oil reserves in the world) decides to get serious about exploiting their energy resources, that means lots of business for oil services companies. However, Russia’s own oil services companies don’t have the expertise of Western ones, and are basically a bunch of mom-and-pop companies. One international firm has aggressively stepped in to supply everything from seismic mapping services to production enhancement for older wells.”

“Already their customer list includes all the major integrated firms and most of the larger independents. And, just for good measure (and political correctness), they just bought a majority stake in the largest independent services firm in Russia.”

Let’s just ignore the fact that hearing yet again about another firm being the “picks and shovels” supplier to the “gold rush” of X industry demonstrates a deplorable lack of creativity … certainly it at least lets us picture immediately what he means, which is the glory of all old saws and cliches.

And this company pretty nearly has to be Schlumberger (SLB).

Schlumberger is the Gigantor of the oil services sector — market cap of about $125 billion, a jack of all trades, and priced like the luxury vehicle it is as the acknowledged class of the industry, with a trailing PE well above its peers at about 25. It’s hard to argue with a company that’s this big but still growing at double-digit rates, so I won’t — you can probably get more “lightning in a bottle” by buying beat up or small oil services companies during boom years like this, but there’s certainly something to be said for steady growth and market dominance.

Schlumberger operates just about everywhere, including Russia, and they did just a couple years back buy a big oil service firm there, PetroAlliance. Can’t be 100% sure on this because the clues are limited, but I’m pretty sure. There’s plenty out there to read on Schumberger, and you’ll not find an analyst who hasn’t heard of them, so if you read up and form a strong opinion feel free to share.

Number 2!

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“America’s natural gas shortage is your natural profit opportunity – Liquid natural gas reserves in the U.S. are approaching dangerously low levels, and a dependable replacement source is desperately needed. One Russian company with huge natural gas reserves is on the verge of stepping up to solve the problem. Right now, it’s negotiating the purchase of its own pipelines and terminating facilities in the U.S. Once its millions of cubic feet of gas start flowing, they will heat millions of homes across America and set the portfolios of far-sighted investors on fire.”

Don’t know that I’d agree that the US has a natural gas “shortage,” especially with so many producers exploring like crazy now that prices are no longer depressed, but it does all of a sudden make sense to import more at these prices.

That’s got to be Gazprom, the natural gas giant that has the Ukraine and all of Western Europe quaking in their Winter boots — and they did bid on the big new Alaska pipeline project, which has lots of folks up in arms. Gazprom does have a pink sheets listing at OGZPY in the US, but I wouldn’t touch them with a 10-foot pole. They might make you wealthy, but I am made very nervous by the extent to which Gazprom appears likely for some time to be a high profile tool for Russian hegemony in Europe, so I’ll look elsewhere. Sometimes I’d prefer to miss an opportunity rather than feel uncomfortable, given the huge number of opportunities in the world, but you may well have a different perspective (feel free to share, of course).

Gazprom does already export some Liquefied Natural Gas to the US, and they may end up buying a LNG terminal in Trinidad from BP (or partnering with them on it), which would make them a larger player in US supply as well.

I hope that didn’t come off as freakishly anti-Russian — I’m not, this is just a situation where my qualms are significant enough to keep me from straying too far into the huge high-profile Russian energy companies that seem like political footballs. In part this is a dislike for the operations, but as an investor these qualms of mine are based more on the fact that you can’t figure out companies like Lukoil and Gazprom just by looking at the financial statements, you also have to read Vladimir Putin’s mind.

Your qualms may vary, and mine may be groundless.

There is one more company that was teased in this ad, but I’m going to hold off on that — It’s for one of the LNG tanker companies, and I’ve been meaning to look at them in some additional detail so I’ll wait until I have time to dig in.

Happy Investing! Here’s hoping that July treats us a little more kindly than June … though the more rational part of me enjoys the nice bear market bargain hunting opportunity, my animal spirits, and my portfolio, are a bit disheveled at the moment.



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A.Nony Mouse
A.Nony Mouse
July 1, 2008 12:57 am

Hmmm.I’m willing to bet the LNG tease is for Teekay LNG Partners or maybe their spin-off corporation not unlike a US fertilizer MLP has done

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Brian B.
Brian B.
July 1, 2008 9:51 am

Lukoil almost went bankrupt due to a russian govt. fine of several millions in back taxes years ago. A bail out incentive may help keep them alive today. So in the Russian govt.’s interest to keep them afloat. I would think it’s a self serving step, but one that is hardly seen as a boon for LUKOIL. Good Investing.

July 1, 2008 10:25 am

Just my personal opinion, but a country with a history of nationalization, is not a country I would want to invest in. Russia, and China as well, scare the britches off of me!

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