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LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

LITASCO SA/ LUKOIL


The “Integrated Trader’s
Compromise”
Gati Al-Jebouri, CEO LITASCO SA

Discussion with CASS Business School

17.02.2009
INTRODUCTION
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

• LITASCO SA is the international marketing,


supply and trading subsidiary of LUKOIL

• This presentation includes the highlights of


LUKOIL’s and LITASCO SA’s full range of
business activities and reflects on the
challenges for a trading company operating
under the umbrella of a major integrated oil
company

1
AGENDA
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

1 Introduction to LUKOIL
2 Introduction to LITASCO SA
3
The “Integrated Trader’s Compromise”

2
LUKOIL GROUP – KEY FACTS
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Net income 2008: circa $12 bln* • LUKOIL is one of the world’s largest private vertically
integrated oil and gas companies
• Operations in over 30 countries and more than
Proven hydrocarbon reserves: 20.4 bln
150,000 employees
bbls
• Market cap near $29 bln**
• 1.3% of global oil reserves and 2.3% of global oil
production
Production of marketable hydrocarbons:
• 18.6% of Russian oil production and 18.1% of Russian
2.06 mln bpd*
oil refining
• The second largest private company worldwide by
proven reserves of hydrocarbons
Refineries throughput: 1.12 mln bpd
• The 6th largest private oil company worldwide by
production of hydrocarbons
• The largest Russian private oil group with annual
turnover near $ 100 bln
Refining in Europe: 0.22 mln bpd*
• The first Russian company to receive full listing on the
LSE
• The only private Russian oil company whose share
capital is dominated by minority stakeholders
Crude and products export: 1.36 mln bpd* • The largest corporate taxpayer in Russia: $33 bln of
taxes and duties paid in 2008 due to highest export
volumes amongst peers
* Preliminary data based on the results announced at Bod 13/01 and Litasco SA analysis **at closing 09/02/09 (RTS&MICEX) 3
LUKOIL GROUP – MISSION AND GOALS
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

• Our purpose is to harness natural energy resources for human benefit


• We aim to support long-term economic growth, social stability, prosperity
and progress in the regions where we operate, as well as caring for the
environment and ensuring sustainable use of natural resources
• We want to achieve consistent and long-term growth of our business
• We have transformed LUKOIL into a leading global energy company
• We want to be a reliable supplier of hydrocarbons on the international
energy market.
• LUKOIL sets the objectives to create new value, maintain business stability
and provide shareholders with high return on their investments through
asset value appreciation and cash dividends.

4
LUKOIL GROUP – KEY FIGURES
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

9 months
2007 2006 2005
2008
Total revenue
89.7 81.9 67.7 55.8
($ bln)
EBITDA
16.7 15.4 12.3 10.4
($ bln)
Total sales volume
88.9 119.1 115.6 112.5
(million tons)
Crude oil production
1.895 1.953 1.926 1.820
(million barrels per day)
Refined products
1.135 1.054 0.978 0.946
(million barrels per day)
Petrol stations
6,758 6,090 5,793 5,830
worldwide

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LUKOIL OPERATIONS ON THE MAP
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Murmansk
Varandey

Timan Pechora
Vitino
Usinsk
West Siberia

Ukhta
FINLAND
Urals
Vysotsk
Primorsk Refineries
Tallinn Perm
St Petersburg
ESTONIA Production

VentspilsLATVIA
Norsi RUSSIA regions
Pipelines
LITHUANIA
Rail
Svetly
Main export
BIELORUSSIA
POLAND Volga ports
Export sea
UKRAINE cargoes
Volgograd
Kumkol
Odessa
ROMANIA
MOLDOVA Yuzhny
Kerch KAZAKHSTAN
Petrotel Novorossiysk
Caspian
Burgas Tuapse
BULGARIA

ISAB TURKEY
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AGENDA
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

1 Introduction to LUKOIL
2 Introduction to LITASCO SA
3 The “Integrated Trader’s Compromise”

7
KEY DETAILS OF THE LITASCO GROUP
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Corporate structure

• 100% subsidiary of OAO LUKOIL


(Moscow)
• Headquarters and company
registration in Geneva
• Over 300 staff in 10 countries
(204 in Geneva)

2008 Results (Unaudited)

• Total sales of $67.5 bln


(about 60% of OAO LUKOIL sales)
• Operating profit of $330 mln
• Crude oil sales of 41.6 mln mt
• Product sales of 56.1 mln mt

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MISSION AND VISION OF LITASCO SA
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Our vision:
To be the leading oil-trading and supply company in Europe
and the FSU, and to challenge the majors in international markets
To ensure the To develop To support the To develop a
successful a global world- growth and strong and
export of class multi- value-added profitable
LUKOIL crude commodity marketing presence in
and products trading business activities of local markets
while achieving based on LUKOIL’s through the
the highest entrepreneurial downstream development
possible (third-party) operations of specialized
netback trading outside Russia businesses

LITASCO SA’ s mission is to maximize the value of LUKOIL’s crude oil and
petroleum product exports and to expand its trading activities into new
areas in the most efficient and safest way possible
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LITASCO SA SITS IN THE MIDDLE OF THE LUKOIL SUPPLY
CHAIN, BRIDGING RUSSIA AND INTERNATIONAL MARKETS
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

LUKOIL
LUKOIL/LITASCO SA Business Activities
LITASCO SA

Refining Marketing
(International) (Wholesale /
Retail)
Exploration Crude Products
and production
(Russia) International Marketing, Supply and Trading
Handles logistics between Russian and international
business units and markets. Trades at own account
Refining
(Russia) Products

International Markets
Marketing
(Russia)
LITASCO SA participates in key transactions along the
petroleum value chain:
• Markets LUKOIL crude and refined products to international
markets
• Supplies LUKOIL and 3rd party crude to LUKOIL refineries
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WHERE DOES LITASCO SA ADD VALUE?
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

LITASCO SA, as LUKOIL’s trading company, exists to add value to


LUKOIL crude and products over and above the FOB value

Point of final sale LITASCO value add area


(typical incoterm)
Delivered to end
Refinery gate Inland transportation Shore tanks Sea transport
customer
(FCA) (DAF) (CPT, DDU) (FOB)
(CIF, DES)

Increasing product value / increasing margin


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LITASCO SA’S CONTRIBUTION TO THE LUKOIL GROUP IS
BASED ON THREE KEY BUSINESS ACTIVITIES
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Location Core activities

Export Geneva Marketing crude oil and refined product exports


marketing to customers outside the Russia and Caspian
region, currently focused in the North-West
European, Black Sea and Mediterranean regions

System supply Geneva & Moscow Managing crude oil purchases (supply) on behalf
of LUKOIL‘s refining and marketing operations in
Eastern Europe (LUKOIL’s Romanian & Bulgarian
refineries and the newly acquired refinery stake
in ISAB, Sicily, Italy)

International Geneva and Entrepreneurial (third-party) trading of crude oil


trading international offices and refined products in international markets
from a network of global trading offices

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TRADING FOCUS OF LITASCO SA’S
MAIN INTERNATIONAL OFFICES
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Stockholm
Rotterdam Hamburg
Geneva
New Jersey

Dubai
Singapore

LUKOIL LUKOIL LITASCO SA LUKOIL LITASCO SA LUKOIL


Pan Americas Benelux Geneva Hamburg Sweden Asia Pacific

Focus of Crude oil and all Local market Crude oil Naphtha Local Marine fuels in
operations products fuel oil and All products Gasoil market Singapore
marine fuels Petrochemicals Gasoline gasoil Trading all
sales products in
Singapore and
the Middle East
Main Transatlantic Benelux coast Baltic - W Europe Africa- Intra-
markets Caribbean US Baltic-Benelux Black Sea – Western Scandinavian Persian Gulf–
served Mediterranean Europe (Gothenburg- India–SE Asia
Benelux-Far
East/US Copenhagen)
NW Russia - Europe
90.6
Volume
traded 8.7
2008, 3.4 5.3
2.5
0.6
mln mt
13
AGENDA
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

1 Introduction to LUKOIL
2 Introduction to LITASCO SA
3 The “Integrated Trader’s Compromise”

14
NOT EVERYONE TRADES
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

• The majority of crude is sold under long term contract


• National Oil Companies mostly sell under long term contracts (NOCs account for 70% of
world production)
• Many contracts prevent selling onwards to third parties
• Specialized crude types (sour, heavy) have specific applications (high-conversion refineries).
Refineries with deep conversion prefer time contracts to ensure security of supply

• The oil majors are not necessarily large traders


• Many oil companies market products, they do not trade them
• Only approx. 20% of non-NOC volume is potentially traded, and even actively trading oil
companies do not trade all of their production
• Majors have a risk aversion and corporate profile that discourages ‘speculation’
• Majors assume that investors can hedge and are seeking long exposure to absolute crude
prices and refining margins

In a large market, with increasing volatility and inactive


participants there is significant scope to develop a large and
profitable trading position
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CATEGORIES OF OIL TRADING COMPANIES
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY
Business model Examples
• Glencore
Pure-play • Exist solely to trade energy and other • Vitol
independent commodities while holding few to no • Marc Rich
trading companies assets • Sempra
• Cargill
• Trafigura

Trading arms linked • Optimize supply procurement and • Total (TOTSA)


product off-take • ExxonMobil
to integrated asset • British Petroleum (BP)
businesses • Monetize asset positions held by core
• Petróleos Mexicanos
business
• Koch
• May also trade for own account and • Shell (STASCO)
offer financial trading instruments and • Petrobras
financial services • Statoil (stopped all products trading)
• ConocoPhillips
• Morgan Stanley (credit impaired)
• Trade a wide spectrum of commodities • Goldman Sachs/J Aron (drastically reduced activity)
Financial while offering other financial products • Louis Dreyfus (stopped trading crude)
houses and services (e.g. derivatives) • Bank of America (stopped all commodity tradings)
• UBS (stopped all commodity tradings)
• Lehman Brothers (bankrupted)
• Barclays (acquired UBS trading activities)
• Credit Lyonnaise (drastically reduced activity)
• Societe Generale (drastically reduced activity)
• Hedge Funds: Citadel stopped all tradings
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SEVERAL TYPES OF BUSINESS MODEL ARE
AVAILABLE TO TRADING COMPANIES
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Trading role Characteristics Value proposition Examples

Asset • Trades only to fulfill basic operational • To maximize day-to-day


optimization needs and contractual obligations margins by optimizing asset
economics
Increasing trading complexity

System trading • Purchases and sells in excess of • To leverage asset position,


system needs to capitalize on unique knowledge, and risk
favorable market prices management expertise to
create additional value

Arbitrage • Leverages price differentials in • To profit from superior


different markets for the same or market knowledge without
related commodities to capture profit taking on large additional
risks

Position taking • Takes naked, long, or short positions • To profit from anticipated
in physical / financial markets to but uncertain changes in
achieve profits through the successful prices by leveraging
anticipation of future price movements proprietary information

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POTENTIAL IMPACT OF TRADING APPROACH
ON SYSTEM PROFITS
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Trading
enhancement to “Pure” traders
system profits Profits for oil majors tend to
extend profits by
plateau as incremental data is less
taking speculative
relevant to the physical business
risks
100%
System profits increase
as the organization gets
access to incremental
market data
50%

Trading System System Physical Financial Position


approach supply optimization arbitrage arbitrage taking

Relative
position of
majors

Trend toward increasing trading sophistication 18


FOCUS OF INDEPENDENT VS INTEGRATED
TRADERS
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

INDEPENDENT INTEGRATED

• Maximizes earnings • Maximizes earnings, but also have to:


• Ensure timely lifting of all system production
• Supply system with appropriate feedstocks and finished
products
• Minimize inventory levels (in order to satisfy financial analysts)
• Comply with corporate guidelines on return on working capital
employed
• Fulfill corporate requirements on safety and environmental
protection
• Use corporate IT systems, financial and accounting procedures
• Meet corporate cash pooling requests

Integrated traders must make a number of compromises to serve the


interests of their parent company

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ADVANTAGES OF THE INTEGRATED APPROACH
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

• Guaranteed volumes
• Low financing costs with the help of the parent company’s
credit rating
• Strong market position, bargaining power
• Participation in system optimization and resulting
participation in profits
• Access to and influence on logistical and asset investments

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LITASCO SA TRADING RESULTS
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

60
Sales by product
category, 50
2005-2008
Million metric tons 40

30

20

10

0
CRUDE OIL FUEL OIL GASOIL GASOLINE OTHER
PRODUCTS

2005 50.87 11.62 14.15 3.24 0.19


2006 45.50 14.17 19.30 3.39 0.23
2007 44.87 18.63 18.80 3.46 0.30
2008* 41.63 29.52 16.04 2.76 0.63
* Unaudited account 21
LITASCO SA FINANCIAL RESULTS
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

500
Profit, 450
2005-2008
400
USD million
350
300
250
200
150
100
50
0
GROSS PROFIT OPERATING PROFIT NET INCOME

2005 465.6 345.9 246.0


2006 342.3 277. 8 223.8
2007 329.1 251.2 198.1
2008* 420.1 330.4 227.3
* Unaudited account 22
LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

BACK UP

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WITHIN EACH TRADING MODEL, PLAYERS WILL ASSUME VARIOUS
TRADING ROLES BACK UP

LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Trading role Description Value proposition

Asset optimization • Trading to fulfill basic operational needs and contractual • Maximizes day-to-day margins by
obligations of an organization. Asset optimizers purchase optimizing asset economics
and sell commodities at levels supportive of their assets and
do not look to profit from purchases or sales in excess of
system needs
System trading • Using operational needs of a system as the basis for trading • Leverages asset position, unique
decisions, but extending beyond asset optimization to knowledge, and risk management
purchase and sell in excess of system needs to capitalize on
expertise to create additional value
favorable market prices. A system trader might purchase
excess quantity with intent to store and resell at a later date
for profit.
Arbitrage • Leveraging price differentials in different markets for the • Profits from superior knowledge of
same or related commodities to capture profit. Arbitragers market dynamics without taking on
avoid risk by simultaneously buying in one market and significant additional risk
selling in another.
Market making • Continual transaction with market participants in attempt to • Provides liquidity by offering to buy
match buyers and sellers to maintain a net neutral position. and/or sell at all times
Market makers quote a buy price lower than their sell price
and capture the spread (bid-ask spread)
Speculation • Taking naked, long, or short positions in physical/financial • Profits from anticipated but
markets with the objective of achieving profits through the uncertain changes in prices by
successful anticipation of future price movements. leveraging proprietary information
Leveraging proprietary information and acceptance of
additional risks with the objective of capturing profits
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OVERVIEW OF PROFILED COMPANIES BACK UP

LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Company Description
Pure-play Glencore Switzerland-based, private company engaged in the physical trading, purchasing, and supply of energy, metals, and agricultural
independent commodities (formerly Marc Rich/Clarendon)
trading
companies Vitol Private, Netherlands-based company focused on marketing physical oil, metals, and agricultural products (primarily sugar)
With limited link to Hess Energy (U.S.)

Hetco Hetco covers the full range of energy Commodities and weather products

Cargill Cargill’s energy division and Cargill-Alliant (Minnesota) trade and distribute crude and refined petroleum products, natural gas,
and power

Trafigura Trafigura is a private, global trader of crude, refined products, natural gas, and metals, with corporate headquarters located in
Lucerne, Switzerland

Trading arms TotalFinaElf French oil company with substantial upstream and downstream activities supported by international trading in both crude and
linked to asset refined products
businesses Equiva Shell’s Houston-based supply and trading arm of Equilon, Motiva, and affiliates of Shell and Texaco that trades crude and refined
products
Based in Irving, Texas, ExxonMobil is the world’s largest oil company and is involved in crude, refined products, natural gas, and
ExxonMobil
chemicals trading and marketing
BP London-based oil company, behind only ExxonMobil and Royal Dutch Shell in size, involved in crude, refined products, natural
gas, and chemicals trading
Pemex PMI, the trading arm of Mexico’s national oil company, Pemex, trades principally refined products
Koch Koch, a privately held company based in Wichita, owns a diverse group of companies engaged in trading, investment, and
operations in petroleum, chemicals, and natural-gas liquids
Dynegy Houston-based Dynegy Marketing and Trade focuses on marketing, trading, and arbitrage opportunities that exist among power, natural
gas, and coal that can be enhanced by the control and optimization of related physical assets and its alliances with leading utility
companies

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OVERVIEW OF PROFILED COMPANIES (CONT.) BACK UP

LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Company Description

Trading Reliant (Houston) uses their natural-gas and power trading skills and extensive asset positions to better understand
Reliant
arms key regions and create sophisticated commercial insights
linked to
Mirant Atlanta-based Mirant pursues an integrated business model that merges risk management and marketing knowledge
asset with operational excellence (leveraging its investment-grade credit) to provide energy commodity and wholesale
businesses energy solutions

Williams Williams Energy Marketing & Trading (Tulsa) is a top-tier, fully integrated energy marketer providing the buying,
selling, and transportation of natural gas, electricity, crude oil, refined products, and natural-gas liquids, as well as an
extensive menu of risk management products

Financial MSDW The commodities department of MSDW trades physical commodities as well as related derivatives for oil, natural gas,
houses power, base metals, and precious metals

J Aron, the commodities division of Goldman Sachs, specializes in over-the-counter options trading of energy,
J Aron precious metals, and agricultural products

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…WHICH INFLUENCES THE REQUIRED MANAGEMENT SYSTEMS…
BACK UP

LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY

Structure Staff Systems Risk management

Asset Asset operations/ Large number of clerks Relatively un- Simple systems with
optimization managers communicate Few traders/risk sophisticated relatively small limits
with dealing room managers Linked to asset Explicit measurement
optimization/ relative to benchmark
logistics/scheduling

System Product dominated by Large number of skilled Low-cost, high-volume Risk monitoring and
trading close origination / trading specialists (trading, dedicated systems individual online trader
Increasing trading complexity

interaction, supported by origination, research, position limits


product research and back back office) Limited cross-market
office capabilities
Revenue desegregation
by source (spread
capture, positioning,
mark-up)
Arbitrage More customer-focused, Highly skilled single and Large, continual Individual trader position
with links among client cross-market traders and investment in analytical, limits and risk monitoring
relationship people, analytical specialists who transaction, and risk Sophisticated cross-
traders, and analytical support client relationship management support market risk analysis
support generalists management
Front and back-office staff Sophisticated pricing
capabilities
Revenue desegregation
by source

Position Trader-dominated Few exceptional risk Large investment Separate trading and risk
taking organization with centrally takers supported by especially in position monitoring functions,
coordinated risk taking traders to access deal monitoring systematic measurement
flows and research staff of intramarket and
to interpret information intermarket risks
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…AND ULTIMATELY THE RISK CONTROL SYSTEMS
BACK UP

LITASCO SA - LUKOIL INTERNATIONAL TRADING AND SUPPLY COMPANY


Best practice risk control organization for various trading strategies

 
system
Mainly

based
Risk control organization
Risk control is the


most important
Components
of both
factor determining
the organization’s
shape


Organization
-based
Mainly

Asset optimization System trading Arbitrage Position taking

Straight-forward nature Increasing complexity High complexity of activities demands significant risk level
of trading activities demands additional of risk monitoring
allows assets to be communication between Information flow requires highly connected, flat
“siloed” along functional asset managers organization
and organizational lines Benefit to organization’s Interface of these requirements points to system-based,
total returns through rather than organizationally-based risk reduction methods
information sharing

Best practice strategy / organization characteristics


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