YUKOS LOSING ITS GRIP ON LITHUANIAN OIL REFINERY

C O N F I D E N T I A L SECTION 01 OF 02 VILNIUS 000380

SIPDIS

STATE FOR EUR/NB AND EB/EPC

E.O. 12958: DECL: 04/10/2015
TAGS: PREL EPET ECON ENRG LH RS
SUBJECT: YUKOS LOSING ITS GRIP ON LITHUANIAN OIL REFINERY

REF: A. VILNIUS 300


B. EUR/RUS/MORENSKI EMAIL 3/31/05

C. VILNIUS 1439

D. VILNIUS 1160

E. VILNIUS 1521

Classified By: Economic Officer Miguel Rodrigues for reasons 1.4(b) and
(d)

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SUMMARY
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1. (C) Russian oil giant Yukos is losing hold of its
controlling interest in Lithuania's Mazeikiu Nafta oil
refinery, as the company can no longer guarantee oil flows to
Lithuania. The GOL has entered into negotiations with
London-based Yukos management regarding control of the
refinery. Russian oil companies Lukoil, TNK-BP, and Rosneft,
as well as ConocoPhillips, all appear interested in Mazeikiu,
the region's sole refinery. Lukoil, promising the GOL
uninterrupted crude supplies and retail outlets for its
finished products, is the rumored frontrunner, but it's not a
done deal. Sale of Yukos' interest in Mazeikiu Nafta to any
of these potential buyers will stabilize Lithuania's oil
supply. End Summary.

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Running on Fumes
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2. (C) Yukos, the majority stockholder of Lithuania's
Mazeikiu Nafta (MN) oil refinery, edges closer to breach of
its contract with the Government of Lithuania and loss of its
53.7 percent share in the company because of its inability to
supply crude oil to the refinery. Despite the company's LTL
721 million (USD 271 million) profit in 2004 (nearly tripling
the preceding year's take),Yukos representative in Lithuania
Tomas Gizas told us that he has only agreements, not
assurances, of crude supply for the second quarter. From
April 1-4, Transneft stopped the flow of crude through the
pipeline because of a reputed "technical problem." In
February, an "accounting" problem stopped the flow for six
days, and forced the refinery to use reserves to keep
production going (ref A). This time, pumping resumed on
April 5, but MN General Manager Nelson English said that he
is confident of delivery of crude only until the end of
April. If Yukos is unable to guarantee crude supplies, it
will lose its status as a strategic investor.

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GOL looks for new strategic partner
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3. (C) MFA Economic Department Counselor Nijole Zambaite told
us that the GOL has been racheting up the pressure on Yukos
to sell. On March 30, Minister of Economy Viktor Uspaskich
announced that the Government had begun negotiations with
Yukos "regarding the further governance of the company,"
having a few days earlier told the press that Yukos
"basically no longer exists." Zambaite acknowledged that the
GOL is already soliciting and talking with potential buyers.
English shared with us that the GOL is in preliminary
discussions with top London-based Yukos management about a
possible sale.


4. (C) Yukos has the sole authority to decide whether to sell
its 53.7 percent holding in Mazeikiu Nafta. The GOL has
first right of refusal to purchase the Yukos-owned shares,
but lacks the funds, according to Vice Minister of Economy
Nerijus Eidukevicius. GOL officials have indicated that they
favor Yukos's buyout by an oil producer that can guarantee
crude flows. The GOL has publicly maintained an interest in
purchasing an additional ten percent stake in Mazeikiu Nafta
if the Mazeikiu Board of Directors authorizes a new share
issue, allowing the GOL to gain control over the refinery.
Under Yukos's contract, Yukos has the first option to buy
this new share issue, and the two parties are currently
negotiating the matter. English told us that freelancers
have inserted themselves in the process, with local Yukos
managers at Mazeikiu Nafta making money on the side by
brokering the sale of refinery shares or oil without
authorization.

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LUKOIL: Anointed in Oil?
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5. (C) GOL energy advisor Gediminas Vaiciunas told us that
the Russian company Lukoil leads the pack of potential buyers
of Yukos's Mazeikiu Nafta shares and that Rosneft is also
still in the race. (Note: Rosneft is also in merger talks
with Gazprom, which holds a 37.1 percent interest in
Lithuania's principal supplier of natural gas.) English
added ConocoPhillips to the list of interested parties, and
said that TNK-BP had not bowed out, although the local press
March 30 quoted company Chairman Robert Dudley's denial of
purchase plans.

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Pitching the Minister
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6. (C) Lukoil country representative Ivan Paleichik told us
Lukoil had made a formal acquisition proposal by letter to
Yukos on March 31, and had contracted Citigroup to appraise
Yukos's MN assets. Paleichik expects Lukoil to complete a
Yukos buyout by June 2005 and to be able to guarantee annual
delivery to MN of five million tons of crude. (MN imported
8.7 million tons last year.) At a meeting with Minister of
Economy Viktor Uspaskich April 1, he said, Lukoil Strategic
Director Gajdamaka Andriej focused on Lukoil's ability to
offer Mazeikiu Nafta a well-developed retail network for its
gasoline products in the three Baltic countries and Finland.
He underscored that Lukoil had come to the rescue during the
interrupted crude deliveries, providing MN a quarter of its
monthly supply.

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Terms of Agreement
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7. (C) Yukos currently has the Mazeikiu Nafta management
contract. Paleichik affirmed that Lukoil would like to
acquire this contract as part of the agreement, as Yukos did
from Williams, but he indicated that this was a subject of
negotiations with the GOL. The Prime Minister's Energy
Advisor Saulius Specius told us that the GOL intends to seek
management rights itself and may impose new requirements on
the new owner of Yukos's holdings.

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COMMENT
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8. (C) We suspect that the Government's talk of acquiring a
greater stake in Mazeikiu Nafta or wresting control of the
management contract from Yukos' buyer is wishful thinking or
posturing. Government control of the company will make a
less attractive deal for interested buyers. It is in the
GOL's interest to keep the competitors circling in order to
get a deal that benefits Lithuania and Yukos. Many
Lithuanians fear takeover by a Russian company with close
ties to the Kremlin would lead to a loss of sovereignty over
critical decisions affecting one of Lithuania's most valuable
assets and increased vulnerability to the use of oil as an
instrument of control. In fact, as the recent oil
disruptions this winter made clear, Russian interests already
open and close the tap at will.
Mull