OIL IN RUSSIAN HANDS The Hungarian CEO of MOL Zsolt Hernadi and the director of Russia's Gazprom, Alexei Miller, after the signing of a deal that will see the Southern Stream natural gas pipeline pass through Hungary; behind the two are Prime Ministers Ferenc Gyurcsany and Vladimir Putin"The entry of Russia's Surgutneftegaz into the ownership structure of the Hungarian oil company MOL is the pinnacle of a ten year effort on the part of Russian companies to conquer the markets of the countries of South Eastern Europe. In many of these markets they already play a dominant role, but they could never access the Hungarian and Croatian markets. But now that Surgut has entered MOL, and thereby the ownership structure of Croatian oil company INA, the groundwork has been laid for Russian firms to gain complete mastery of the energy markets of South Eastern Europe, from Slovenia to Bulgaria. This dominant position is one of the long-term goals of Russian policymakers, and it is to be expected that there will, in the coming period, be increased Russian political pressure on the Hungarian and Croatian governments. The Russians are, namely, aware that their dominant positions on these markets allow them to increase Europe's dependency on their energy and there is no doubt that they will do all they can to achieve their goals," Nacional was told by a respected Croatian oil expert who wishes to remain anonymous.

The concern expressed by Nacional's source is understandable. With the purchase of a stake in MOL from Austria's OMV, the Russian oil company Surgutneftegaz has practically gained influence over the entire Hungarian energy system, and of the management of Croatia's INA. The dominant position in Bulgaria is held by Lukoil, which also has operations in Serbia, Bosnia & Herzegovina, Montenegro and Croatia. Russia's influence in Serbia was further strengthened last year when state-owned Gazprom took over the Naftna industrija Srbije Company, while in Bosnia & Herzegovina Russia is present through the ownership of the Naftna industrija Republike Srpske. That is why it is easy to conclude that Russian-owned companies could soon gain mastery over the entire region.

From today's perspective it is clear that the dominant position of Russian companies in South Eastern Europe did not come by chance, that there was in fact a long-term strategy at hand, both through the business sector and politically. The business strategy has unfolded over an entire decade, and during that time some companies made moves that meant short-term losses, but it is clear now that these moves were part of a much broader strategy. The Russians expanded in the region above all by buying up existing firms, but when that did not work, they set up their own branches and developed their business from scratch. That was a very costly process, but their approach was to a large extent coordinated, and it will result in the final tally with Russian companies achieving almost complete control of retail sales, refineries and oil and natural gas transport systems in the countries of South Eastern Europe over the next few years. This dominant position will also result in a greater Russian political influence on events in the region. And since some of the countries in the region are already members of the European Union, and considering that others will become members in the future, it can be assumed that the Russians are building their future political levers within the European Union itself. That is why, in fact, the entry of Surgut into the ownership structure of MOL can be considered not only a business triumph, but also the geopolitical success of a ten-year Russian strategy.

The implementation of this strategy began back in 1998, when the Russian oil company Lukoil built its first petrol filling station in South Eastern Europe, in the Bulgarian capital of Sofia.

Lukoil is one of the largest oil companies in the world, and is also considered the most transparent Russian oil company. The reason for that lies in the fact that Lukoil is privately owned, and that one of the larger stakeholders in the company is the US-based ConocoPhillips. Lukoil shares are traded on the world's major stock exchanges, which is why the company has to meet very strict conditions in the transparency of its operations. For this reason the influence of Russian policy makers on the business operations of Lukoil is much less that is the case with Surgut, Rosneft or the state-owned Gazprom. Nevertheless, although the level of influence is lesser, there are still firm connections, even formal ones, so that, for example, the company has a signed contract with the Russian foreign ministry on the basis of which the Russian diplomatic network around the world promotes and protects the interests of Lukoil. That is why many are of the opinion that Lukoil enjoyed significant support from the Russian government when expanding its operations to Bulgaria, and especially in Serbia.

Just a year after starting up business in Bulgaria, namely, Lukoil purchased a 58 percent stake in the Neftochim refinery, located in the Black Sea city of Burgas, from the state for 101 million dollars. This is the largest refinery in South Eastern Europe, and experts feel that it was sold to Lukoil significantly below its real value. Nevertheless, over the past ten years the company has invested a little over 300 million dollars into developing Neftochim, and the refinery has proven to be a base for the development of the company in the entire region. Today in Bulgaria Lukoil is one of the largest businesses.

The company generates a total of 9 percent of the Bulgarian GDP, and pays a total of 25 percent of all tax revenue to the state. It is not difficult from this to conclude just how vast the influence of Lukoil on Bulgaria is, and if we add to that the fact that Bulgaria covers over 95 percent of its requirements for oil and natural gas via imports from Russia, it can also be assumed that the influence of the Russian political leadership is also great. This influence has resulted in Bulgarian support for all Russian energy projects, the latest of which is the Burgas-Alexandroupolis oil pipeline, which should make this Greek city the Mediterranean exit port for Russian oil.

Few saw Lukoil's business operations in Bulgaria as the beginning of the expansion of Russian companies in the region, even though Bulgaria was for Lukoil later a base for the development of its operations in the other countries in the region. In late 2003 the company undertook its largest investment when it purchased a 79.5 percent stake in the Serbian oil company Beopetrol for 117 million euro. Beopetrol owned about 200 petrol filling stations, and held 20 percent of the retail market for oil derivatives in Serbia. Most of these petrol filling stations were once owned by INA, and were seized by Serbia when war broke out.

Beopetrol's service stations were, however, outdated, and many were burdened with numerous property rights problems. Lukoil spent over five years and 76 million euro bringing the company into order and before it managed to operate in Serbia at a profit. The problems in Serbia somewhat slowed the expansion of the company's operations, so that the next acquisition in the region came only two years later.

On 17 August 2005, based on a deal hammered out with the Macedonian Government, a Lukoil subsidiary was set up in that country which now runs a dozen service stations. Many analysts were amazed at the time that a company as large as Lukoil would spent significant resources on a market as small and closed as that of Macedonia, but it is clear that the company felt that it was important to secure a presence in every country in the region.

In 2006 they tried to do business in Slovenia, by way of a strategic partnership with the Slovenian state-owned company Petrol. The deal was thwarted by Slovenian Prime Minister Jansa, allegedly after receiving direct instructions from Brussels to do so. Nevertheless, Lukoil that same year continued to expand its business, and in October of 2006 a subsidiary company was set up in Montenegro.

AFTER the Surgutneftegaz Company purchased a stake in Hungary's MOL, the Russians have gained complete control of the energy markets from Slovenia to BulgariaNegotiations were launched that same year on the privatisation of the Naftna industrija Republike Srpske (NIRS) with Russian investors. The company includes a crude oil refinery in Bosanski Brod, an oil refinery in Modric and the Banja Luka-base Petrol distribution company. The deal was wrapped up ten months later. And while Milorad Dodik, the Prime Minister of Republika Srpska, said at the time that it was an excellent deal for Republika Srpska, and that the Russian partners would invest significant funds into developing the refineries, a report by the local branch of Transparency International says that the entire transaction was marked by a number of irregularities. Dodik claimed that the refinery was being sold to the Russian company Zarubezhneft, even though the formal owner of the refinery turned out to be an entirely unknown company called Neftgazinkor, while the money was sent from the account of the Russian commercial bank Vneshekonombank. The true owner of the refinery is, then, unknown, and there are doubts that they are people close to the Gazprom leadership.

Transparency International established that in subsequent annexes to the contract the Republika Srpska undertook the obligation to cover all of the company's financial obligations of about 200 million euro. On the other hand, says the report, the Russian owners invested 112 million euro into the company, but the loan was secured through NIRS, and will in the end be repaid through the company's earnings. What's more the Russians did not even construct the 40 million euro railroad that would connect the refinery with the state's rail system. In this way, they say at Transparency International, NIRS was handed over to the Russians, and the transaction could cost the taxpayers about a billion dollars.

The arrival of the Russians in Bosanski Brod has seriously hurt the operations of Croatian oil company INA. In the past, INA sold a large quantity of its production to that market, especially as a result of the somewhat lower quality standards there. But since the overhaul of the refinery at Bosanski Brod, it is selling fuels at prices significantly under INA's. According to some analysis the refinery generates operational losses of a hundred million euro, above all as a result of massive costs. In its production processes, for example, the refinery also produces huge amounts of fuel oil, but of very poor quality, which cannot as such be exported to the markets of neighbouring countries. As a result the owners are forced to transport the fuel oil to Italy where it is destroyed in special plants. This practice results in massive losses, but the owners of the refinery are evidently well aware of this and are doing so just to weaken INA on the market of Bosnia & Herzegovina on the long term.

On the other hand, in 2007 Lukoil began to show a serious interest for the Croatian market. The company tried to buy Tifon from retired General Ivan Cermak. Tifon was then a significant retail chain with 36 modern petrol filling stations, some twenty new locations and with a market share of 7 percent. The acquisition of that kind of retail chain would have allowed Lukoil to compete with INA within a very short span of time, but Hungary's MOL made a better offer, and Lukoil was forced to delay its entry to the Croatian market. It did so only in April of 2008 when it purchased a small Croatian firm called Europa Mil, with eight service stations and a river terminal in Vukovar.

Almost parallel to this acquisition, the company purchased the Roksped chain of service stations in Montenegro for 26.5 million euro. Still, few saw Lukoil's operations in the region as a threat, above all because of the positive image it had as a privately owned company. That attitude changed only after companies under the direct control of the Russian leadership began operating in Serbia and Bosnia & Herzegovina.

And so in late 2007 a third Russian player emerged in the region, and this time it was the Russian state-owned Gazprom. It intended to buy the Naftna industrija Srbije (NIS) from Serbia by way of its daughter company Gazproneft. The negotiations were lengthy, but late last year a deal was finally signed on the basis of which Gazprom purchased 51 percent of the Serbian oil company. The Russians paid 400 million euro for NIS and agreed to invest a further 550 million euro by 2012. The deal was signed by the government of Prime Minister Vojislav Kostunica, and independent analysts claim that the company was sold significantly under value, with the aim of securing Russian political support in campaigning against the independence of Kosovo.

A price of 400 million really does seem too small if one has in mind that the company employs about 14 thousand people, owns two refineries in Pancevo and Novi Sad, an oil and natural gas distribution system, 500 petrol filling stations, 8 crude oil terminals and 44 storage facilities. Just in 2007 NIS saw profits of 170 million US dollars, and it paid the state 1.2 billion euro in taxes. A further argument in the estimation that the deal was politically motivated emerged when it was discovered that Gazprom plans to get the money for the promised investments by loans it will take out on the Serbian company's account. And, Gazprom still has not guaranteed Serbia the arrival of the Southern Stream natural gas pipeline, or the construction of a subterranean natural gas storage facility in Banatski dvor as was initially agreed. That is why it can be concluded that Serbia has handed over control of its energy system to Russia at a The head of Surgutneftegaz could soon also control the operations of MOL and INAvery cheap price. The Russians could gain a similar kind of control in Hungary if they succeed in gaining a dominant ownership position in MOL. Besides, namely, the fact that MOL holds the greatest market share in the retail sale of derivatives in Hungary, and is the owner of two refineries, which are considered to be the most efficient in Europe, MOL is also the owner and operator of the entire natural gas and oil pipeline system in Hungary.

This distribution system has enormous strategic significance, and since there are very serious indications that one of the co-owners of Surgut is Russian Prime Minister Vladimir Putin, it is easy to conclude that it could soon fall under the direct control of Russian policy makers. This outcome could have two very important consequences. The first is that through control of the energy distribution system Russia would gain significant control over Hungarian policy makers – and since the country is a member of the European Union, the influence is all the more valuable. The other consequence pertains to the possibility the Russia could thwart the development of new natural gas distribution routes in Europe through its control of MOL. Hungary has to date, namely, because of its geographic position, and very developed natural gas infrastructure, been considered a key country for the construction of new natural gas pipelines to supply Europe. Hungary is to be the location of the hub of the Russian Southern Stream natural gas pipeline and the hub of the Nabucco natural gas pipeline being pushed by the European Union and which should reduce Europe's need to import Russian natural gas. Now that Surgut has a stake in the company that controls the distribution system in Hungary, Russia has gained a formal foothold through which to push its natural gas pipeline and hamper the construction of Nabucco.

They are aware of this in Hungary and the MOL board of directors is trying to change the company Statutes to reduce the influence of Surgut on MOL's affairs, which would under normal circumstances be significant. The main guideline of the new rules would be that no decisions regarding changes in the company's board of directors could be adopted without a three-quarter majority of votes. In that way, Surgut would need to own 75 percent of the company in order to be able to sack the company's board of directors, led by Zsolt Hernadi, who continues to enjoy the strong support of the Hungarian government. But it is very questionable if these provisions would be in line with European free market protection rules.

It is also an open question as to how other MOL shareholders will accept these kinds of provisions. From the business standpoint, namely, the partnership of Surgut and MOL could likely prove very profitable for both companies. The Russian company has massive reserves of crude oil and natural gas, and has a developed production, but lacks significant refinery capacity and a developed distribution and retail network. And that is precisely what MOL has, which means the operations of the two companies could be very complementary. All those MOL shareholders who expect only as big a profit as possible from the company are probably happy with the possibility of collaborating with Surgut. And that is why it is very questionable as to just how many will be willing to support the efforts of the board of directors in limiting the influence of the Russian company. That is why the decision could wind up disappointing the shareholders, many of who might decide to sell their shares to the highest bidder, and that is at this moment almost surely Surgut or one of its allied funds. With all of this in mind it is not hard to see that Hungary faces an upward struggle if it wants to stop Surgut from gaining control of MOL.