WHO WILL WALK OFF WITH THE BALTICS' ONLY OIL REFINERY?

C O N F I D E N T I A L SECTION 01 OF 03 VILNIUS 000781

SIPDIS

DEPT FOR EUR/NB, EUR/RUS, EB/ESC, INR

E.O. 12958: DECL: 07/27/2015
TAGS: ECON, ETRD, PREL, PGOV, EPET, ENRG, RS, LH, HT25
SUBJECT: WHO WILL WALK OFF WITH THE BALTICS' ONLY OIL
REFINERY?

REF: A. VILNIUS 380
B. 02 VILNIUS 1879

Classified By: Economic Officer Scott Woodard for reasons 1.4 (b) and (
d)

1. (U) This cable contains an action request. Please refer
to paragraph 13.

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SUMMARY
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2. (C) Yukos is likely to sell its majority share in the only
oil refinery in the Baltic countries in the near future.
Several of the world's largest oil companies have expressed
interest in purchasing Yukos's portion of Mazeikiu Nafta. A
consortium controlled by Gazprom appears to be in the
strongest position to buy the refinery. Other companies with
a strong Russian connection, like TNK-BP or a
ConocoPhillips/Lukoil consortium, are still in the running.
According to the shareholder agreement, the GOL can veto a
prospective buyer. The GOL would like to sell Lithuania's
largest corporate asset to a Western-owned or at least
Western-oriented company, but Russia's control of the crude
oil that supplies the refinery gives it the ability to tilt
the playing field in favor of firms favored by the Kremlin.
END SUMMARY.

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MAZEIKIU NAFTA: THE BASICS
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3. (U) Mazeikiu Nafta (MN) is the only oil refinery complex
in the Baltics. In addition to the actual refinery, the
corporation also owns the oil terminal port facility at
Butinge on the Baltic coast and the Birzai pipeline, which
connects the refinery to a pipeline in Belarus that delivers
the refinery's supply of Russian crude oil. MN is
Lithuania's biggest industrial facility and generates some 10
percent of the country's GDP. It produced revenue in 2004 of
approximately LTL 7.7 billion (USD 2.7 billion),more than
double the revenues of Lithuania's next largest company. Its
pre-tax profits last year were more than LTL 900 million (USD
310 million). Yukos is the majority shareholder of MN,
holding 53.7 percent of shares through a company registered
in the Netherlands. The GOL is the other major shareholder,
with a 40.6 percent stake. The remaining 5.7 percent of
shares are actively traded on the Vilnius bourse and are held
by various individuals and institutions.

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YUKOS APPEARS READY TO SELL . . .
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4. (U) Yukos International UK BV bought MN from Williams
International (a U.S.-based company) in 2002 (ref B). Last
March, Yukos's tax and legal problems in Russia began
hampering its ability to provide MN with the amount of oil
stipulated in its agreement with the GOL (ref A). Sensing
that MN would soon be put up for sale, high-level executives
from several of the world's major oil companies, including
TNK-BP, Gazprom, KazMunayGaz, PKN Orlen, Lukoil, and
ConocoPhillips visited Lithuania in May and June. Neither
Yukos nor the GOL has announced a date for the sale.

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. . . BUT NOT WITHOUT THE GOL'S CONSENT
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5. (C) Yukos cannot simply sell MN to whomever it wishes,
even though it is the majority shareholder. Vice Minister of
Economy Nerijus Eidukevicius, who is also a member of MN's
management board, told us that MN's shareholder agreement
gives the GOL's representatives on the board authority on par
with the majority shareholder for all major decisions.
Specifically, this means that Yukos must seek GOL consent for
any deal worth more than LTL 10 million (USD 3.4 million),
giving the GOL an effective veto on the sale of Yukos's
majority holding.

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WHAT DOES YUKOS WANT?
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6. (C) Jurgis Vilemas, who directed the Lithuanian Energy
Institute for more than 20 years and informally advises Prime
Minister Algirdas Brazauskas on energy matters, told us that
what Yukos wants is simple: as much money as possible. Some
press articles have speculated that Yukos may also be in a
hurry to sell its shares before legal action in the
Netherlands or Lithuania (see para 10) possibly freezes its
assets or otherwise hinders its room to maneuver.

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WHAT DOES THE GOL WANT?
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7. (C) Vice Minister Edukevicius told us that the GOL will
want to renegotiate with a potential buyer some of the
technical agreements that tie the GOL, MN, and a new majority
shareholder together. He implied that the GOL would prefer a
company willing to operate MN in a manner that respected the
GOL's interests -- most notably, ensuring a constant supply
of crude oil for the refinery.

8. (C) Vilemas echoed this point, saying that the GOL needs a
buyer who can ensure a steady supply of oil, but stressed
that it also wanted a company with a "Western style" of
management. He said that MN had done well under Yukos's
leadership, which had increased MN's abilities to produce
different types of refined products and opened new markets.
He also said that TNK-BP would be the GOL's first choice as a
buyer of MN because it offered the best combination of
Western management and guarantee of supply.

9. (C) The head of the Social Democratic parliamentary group,
Juozas Olekas, told us that the Prime Minister (also a Social
Democrat) would put economic considerations first. He said
that the PM believed that the economic realities of
globalization would strongly influence any buyer of MN and
prevent it from becoming a tool to be used for political
ends. In his view, this means that the PM would be looking
for a company that will continue MN's development and
increase its ability to create new products and find new
markets.

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THE RUSSIA FACTOR
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10. (C) Dr. Gitaras Nauseda, an industry analyst and adviser
to the CEO of one of Lithuania's most prominent banks, told
us that the Russian government has significant leverage in
determining who will buy MN. He stressed that since Russia
controls the supply of oil, any buyer not to the Kremlin's
liking faces the very real prospect of being cut off.

11. (C) Nauseda also told us that the Russian government's
recent letter to the Netherlands and Lithuania asking the
governments of those countries to freeze Yukos's assets
because of the company's tax liabilities in Russia is most
likely a lightly veiled threat intended to scare off any
non-Russian buyers. The legal status of these requests is
not clear at present, but the GOL stated last week that it
had received the letter and that its lawyers were examining
the possible legal implications. He said that it was
probably not a coincidence that the letters to the Dutch and
Lithuanian governments came soon after Gazprom's announcement
that it wished to expand its oil interests.

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GOL STILL WILLING TO CONSIDER AMERICANS
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12. (C) Olekas told us that potential buyers still have an
opportunity to influence the GOL's decision. He mentioned
that ConocoPhillips did not manage to convince Prime Minister
Brazauskas that it was a serious contender when its officials
visited Lithuania in June. He said that the company still
had time to make a stronger pitch.

13. (C) Vice Minister Eidukevicius expressed some interest in
a ConocoPhillips bid, but said that he would like to
understand the company's partnership with Lukoil better. He
asked specifically if the USG could provide information
clarifying the relationship between these two companies.
(ACTION REQUEST: While we will work our own sources, we
would appreciate any information from the Department on this
relationship, especially if ConocoPhillips decides to bid on
Yukos's shares. END ACTION REQUEST.)

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POTENTIAL BUYERS KEEPING QUIET
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14. (C) The visits of oil company executives to date have
been generally quick and quiet, with brief reports appearing
in the press only the day after. (A lobbyist working for
ConocoPhillips advised us of that company's visit just before
it occurred.) Only one potential buyer has requested a
meeting with emboffs. Shawn McCormick, Vice President of
International Affairs for TNK-BP, met with us twice during
visits to Lithuania. During his second visit on May 26 he
told us that TNK-BP officials had again met with Prime
Minister Brazauskas, who gave the officials the clear
impression that TNK-BP was his primary choice as a buyer of
MN. McCormick told us that TNK-BP was definitely interested
in acquiring MN, but said that his company "would not
overpay," noting that anything more than USD 600 million to
USD 800 million probably would be too much.

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DON'T BELIEVE EVERYTHING YOU READ (IN THE PRESS)
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15. (SBU) Many articles in the local media recently have
contained incorrect information about Mazeikiu Nafta, the
number of shares potentially for sale, the various technical
agreements governing MN's management, and the importance of
obtaining a majority share. It appears that these
journalists erred mainly because of ignorance of a fairly
complicated subject or failure to do proper fact-checking.
Another likely factor is that people with an interest in a
particular outcome may be feeding the press biased or
incomplete information.

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COMMENT
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16. (C) The GOL faces a serious dilemma. Its leaders want a
Western-oriented firm to purchase Yukos's shares. If Russia
chooses to apply all the pressure it can on behalf of Gazprom
or another Russian company, however, it will be very
difficult for any other company to convince the GOL that it
can guarantee the crude oil supply necessary for Mazeikiu
Nafta to function properly.
Kelly