A s s i g n m e n t 4

A C a s e S t u d y o n L OK OI L s Tr a d e S t r a t e g y a t a
P r i v a t i z e d E x p o r t e r








Prepared For:

Mahfuza Khatun
Lecturer and
Course Teacher, International Business

Prepared By:

Zinat Ferdous (ID: 1249)
Nazia Ahmed (ID: 1254)
Md. Rasel Hossain (ID: 1266)
Md. Abdul Ali (ID: 1279)
Waish Hasan (ID: 1295)

First batch, MBA Program


Department of Finance & Banking
Jahangirnagar University, Savar, Dhaka -1342



June 25, 2014
A Case Study on LOKOILs Trade Strategy at a Privatized Exporter

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Case Summary

Russias GDP grew by 7% in 2006, which marked five straight years of growth. The growth was
also higher than that of any other G8 country. Russias oil and gas sector has fuelled the growth,
accounting for about 25% of its oil production and exports the other 70%. This dependence on
petroleum exports makes Russia quite vulnerable to what happens in global petroleum markets.
When the price per barrel of oil changes by $1, Russian revenues change by about $1.4 billion in
the same direction. In recent years, so much oil has been discovered in Russia that the
country now has 15%% more proven reserves than Saudi Arabia. In addition, diplomatic
negotiations to solicit Russian support for the war against the Taliban and Qaeda in Afghanistan
gained Russian control over oil exports from oil-rich Azerbaijan and Kazakhstan in Central Asia.
Russia depends on its oil companies to export sufficient oil to pay for imports, primarily
machinery, to spur its economic development needs.

LUKOil was one of several companies created in 1991 out the Russian state-owned
petroleum monopoly. Since then, the Russian government has gradually reduced its LUKOil
holdings. It sold three-quarters of its remaining 10% holding to ConocoPhillips in 2004. Yet
LUKOil remains close to the Russian government. At present, LUKoil is Russias largest oil
company and is either the worlds largest or second largest private owner of proven
reserves. It controls 19% of Russian oil production and refining. In addition to its large
investments with Russia, it has been making extensive investments abroad. Between January
1999 and September 2000, oil prices tripled because of production cutbacks by the Organization
of Petroleum Exporting Countries (OPEC), bad weather; and strong demand. Oil prices lost
about half this gain because of economic uncertainty after 9/11, but they have since increased to
all-time highs as a result of such factors as unrest in Venezuela, the war in Iraq, Chinese
economic expansion, and production curtailment by OPEC. The result is that LUKoil has been
able to sell more oil outside Russia and at a higher price than it could a few years earlier.
This favorable market situation enabled LUKOil to have enough capital to invest abroad if its
management reasoned that such investment would help its strategic position. In addition to
exporting to use its capacity, LUKOils management has wanted foreign expansion to get
bigger margins and more assurance of full on-time payment than it can get within Russia.

There are several reasons LUKOil engages in foreign investment rather than simply exporting.
First, oil prices have fluctuated widely in the past in spite of their general upward trend since the
beginning of the twenty-first century; so has the ability to market Russian oil abroad. So
LUKoil emulated its larger Western competitors and embraced the ideal of forward integration
into ownership of foreign distribution. Simply stated, when producing companies invest in
distribution, the capture markets that better enable them to sell their crude oil when there
are global oversupplies. Further, this integration could potentially reduce LUKOils operating
costs because LUKOil will not have to negotiate and enforce agreements by selling oil to other
companies in these countries.

Second, despite having huge reserves in Russia and being a successful exporter, political
relations could impair LUKOils future export sales. Further, within Russia the government
owns the pipeline system through which virtually all Russian oil exports pass. Because it
allocates quotas among oil companies to use the pipeline system, a competitor might gain
A Case Study on LOKOILs Trade Strategy at a Privatized Exporter

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influence with Russian political decision makers to pre-empt part of LUKOils quota. Thus,
LUKOil sees the need to develop foreign oil supplies and aims to make them about 20% of its
total supplies.

Third, to be a major global competitor, LUKOil must become as efficient as the major
Western oil companies. To do so, it needs the latest petroleum technology, marketing skills, and
operating efficiencies. Within Russia, these needs have created only minor problems because
LUKOils competition has been other Russian oil companies that also inherited operational
inefficiencies from the former state-owned oil monopoly. However, new competitive threats
within Russia have been gaining momentum. Thus, LUKOil sees advantages in acquiring skills
from foreign companies to help it compete better, both at home and abroad. It also sees foreign
acquisitions, such as the Getty acquisition in the Unites States, as a means of gaining
experienced personnel, technology, and competitive know-how.

Answer to Questions

1. What theories of trade help to explain Russias position as an oil exporter? Which ones
do not, and why?

The following four theories of trade help explain Russias position as an oil exporter:

Theories of absolute and competitive advantage: Both the theories of absolute and
competitive advantage help explain Russias position as an oil exporter. Prices in the
global oil market are driven by the laws of supply and demand. Given the fact that Russia
now has 15% more proven reserves than Saudi Arabia and its oil companies have become
major global competitors, the country enjoys both natural and acquired advantages with
respect to oil.

Factor proportions theory: Given the fact that Russia now has 15% more proven reserves
than Saudi Arabia and its oil companies have become major global competitors, thus factor
proportions theory is applicable.

Country Similarity Theory: The fact that a preponderance of its foreign expansion has
been to countries of the former Soviet Union supports the country similarity theory.

Diamond of national competitive advantage: Porters Diamond of national competitive
advantage also helps to explain Russias position as an oil exporter. Global demand
conditions are favorable; and Russian oil companies are making significant strides in the
areas of factors conditions, related and supporting industries, and firm strategy, structure,
and rivalry.

On the other hand, neither the interventionist theory of mercantilism nor the theories of
country size apply in this case. Further, product life cycle theory does not apply because
petroleum is not an appropriate type of product for that model.


A Case Study on LOKOILs Trade Strategy at a Privatized Exporter

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2. How do global political and economic conditions affect world markets and prices of oil?

Global political and economic conditions affect world markets and prices because of their real
and perceived effects on global supply. In spite of their general upward trend, oil prices have
fluctuated widely in response to events during the twenty-first century. OPECs supply quotas,
general economic uncertainty, Chinas economic expansion, political unrest in Venezuela, and
the war in Iraq have all contributed to the favorable market conditions that have led to record-
setting prices and profits in the global oil industry.


3. Discuss the following statement as it applies to Russia and LUKoil: Regardless of the
advantages a country may gain by trading, international trade will begin only if companies
within that country have competitive advantages that enable them to be viable tradersand
they must foresee profits in exporting and importing.

Given the globalization of the Worlds oil industry on the one hand, and the massive capacity of
Russias oil producers on the other, it is vital that Russias domestic companies have competitive
advantages that enable them to operate profitably in global markets. Otherwise, foreign
competitors that can do so would be in a position not just to serve the worlds markets, but to
enter the Russian market via foreign direct investment, if such action were permissible. Thus, it
is critical that both LUKoil and other Russian oil companies become as efficient as the major
global competitors, either by developing or acquiring the latest petroleum technology, marketing
skills, and operating efficiencies that will yield the efficiencies required to effectively to compete
at both the global and local levels.

4. In LUKoils situation, what is the relationship between factor mobility and exports?

Capital, technology, and skilled employees are all critical factors in the global oil industry. Even
in Russia oil production and processing are capital-intensive activities that require massive
amounts of highly valuable and highly specialized capital equipment manned by skilled laborers.
Investment naturally flows to those sites where oil is abundant and production activities are the
most efficient. Because oil is a limited resource and its demand exists the world over,
competitors such as LUKoil serve their global customers via production sites that are scattered
across the world. Whereas LUKoils European customers will likely be served from its European
OPEC makes supply
uncertain
Chinese
industrialization
increases demand
Political unrest in
Venezuela and war in
Iraq makes supply from
competition uncertain
A Case Study on LOKOILs Trade Strategy at a Privatized Exporter

4 International Business









reserves, other customers are more likely to be served by oil sourced from its holdings in other
parts of the world.

5. Compare the role of the Costa Rican government in the chapters opening case with the
role of the Russian government

The roles of the two governments are quite different in the sense that Costa Rica set about
developing acquired advantages in targeted industries, while Russia chose to exploit its given
natural resources in order to compete in global export markets as it transitioned to a market-
based economy. Although exports of coffee and bananas are still important to Costa Rica, high-
tech manufactured products (electronics, software, and medical devices) are now the backbone of
that countrys economy and export earnings. On the other hand, as Russia moved through the
transition from a centrally-planned to a market-based economy, it fashioned competitive
enterprises such as LUKoil from its state-owned assets. Those firms have since had to rely on
their earnings in order to develop or acquire needed products, processes, facilities, and/or
employees.





Bibliography

Daniels, G., Radebaugh, K., & Sullivan, P. (2011-2012). International Business: Environments
and Operations (12th ed.). Prentice Hall.


Developed acquired
skills in targeted
industries.
Transformed
economy from
exporting natural
resources to high-
tech manufactured
products
Costa Rica
Exploited demand
for their surplus of
natural resources
Transformed state-
owned business to
competitive privately
owned enterprise
Russia