Lukoil: Trade Strategy at a Privatized Exporter

Assignment 2
Lukoil: Trade Strategy at a Privatized Exporter
Word Count: 1946
Introduction
Over the past decade, Russia has witnessed year after year of
significant growth in terms of its GDP. The vast majority of this growth
can be attributed to Russias most valuable natural resource, Crude Oil.
Overall, the oil industry accounts for a staggering 25% of Russias total
GDP, as well as totaling 40% of all exports leaving its borders
(Poussenkova, 2010).
Lukoil, Russias largest oil company came about in 1991, when the then
state owned oil monopoly was dismantled (Firlej, 2009). Today Lukoil
accounts for roughly 19% of all oil production in Russia with profits
reaching $108 Billion in 2008. Despite tremendous success in recent
times for Russian oil exports, the state now looks to offset the risks
associated with both heavily fluctuating oil prices as well as its enormous
dependence upon oil exports for the well being of the nation. Because of
this, companies such as Lukoil are now engaging in foreign investment
to reduce the effects of fluctuating oil prices, political uncertainty as well
as other risks related with their position (Firlej, 2009). This paper will
discuss various aspects of Russias position as an oil exporter as well as
various risks that may be faced in the near future.
Theories of Trade
When talking about Russias global position as an oil exporter, it is best
to use various trade theories to help explain the situation. Firstly, it must
be pointed out that the current situation for Russian oil exports is that of
a competitive advantage over its foreign counterparts (Gurkov, 2010).
Since the oil industry is subject to the laws of supply and demand,
Russia currently stands in great stead, as its proven reserves of crude
oil are more than anywhere else on earth (Poussenkova, 2010). As a
result of the seemingly endless supply of crude oil, Russian oil

companies benefit from a competitive advantage over their rivals

(Gurkov, 2010).
Further adding to this advantage is the steps taken in recent years by
companies such as Lukoil to invest abroad into the latter stages of
distribution. Taken control of the distribution channels is a strategic
action that enables a company to cut costs, mainly because agreements
do not have be upheld between entire network, as well as a reduction in
the number of companies taking a cut of the potential profits (Gurkov,
2010).
Moreover, due to the vast quantities of oil reserves that Russia holds,
the state benefits from a natural and acquired advantage in terms of its
oil (Firlej, 2009). When observing Russian oil exports, it can also be
seen that a large quantity of its oil exports are heading to local countries,
many of which where former members of the Soviet Union (such as
Azerbaijan and Kazakhstan). That being said, this information would
suggest that Lindners Country Similarity Theory would help to explain
Russias current position as an oil exporter. This theory suggests that
that majority of trade between nations should be with other states that
maintain similar levels of economic performance (Russias GDP per
capita is around $16,000) (Firlej, 2009).
Another useful theory to explain Russias position is that of Porters
Diamond of national competitive advantage. This theory deals with
natural resources that a country was lucky enough to inherit as well as
new factor endowments that are created (Firlej, 2009). It is easy to see
why this theory would pertain to the current situation of the Russian oil
industry. Demand for oil worldwide has reached an all time high and
continues to rise, which means that the oil reserves Russia has available
puts them at a great advantage. Furthermore and as previously
mentioned, Russian oil companies as well as the government are taking
huge strides to better the industry by reducing risk, increasing efficiency
as well as overall profitability (Firlej, 2009).
Despite these positive steps, Russia still lacks in the technology
department and therefore an absolute advantage would not help to
explain their current situation. The efficiency of oil production as well as
the technology used in Oil extraction and refining in the United States for
example, yield production costs that are significantly lower per unit than
that of Russias oil industry (Firlej, 2009). However, contrary to this

argument, if foreign investment from the Russian government or

companies such as Lukoil continues along the line of distribution, then
an absolute advantage may result.
Other theories that do not really help to explain Russias current position
include the Mercantilism theory, which was developed in the 16th and
17th century. This theory suggested the encouragement of exports and
discouragement of imports. Although Russia is running a trade surplus,
this is mainly due to the huge export rate of oil and not to the
discouragement of imports.
The theory of country size also is irrelevant. Although this theory does
suggest that larger countries have more varied climates and more
natural resources, which is true for Russia, it also suggests that they are
more self-sufficient. In terms of trade, Russia relies heavily upon exports
and therefore cannot be considered self-sufficient (Firlej, 2009). The
PLC theory is also irrelevant since oil is a natural resource that is a
necessity rather than a want or desire.
Global Political and Economical Conditions
Despite the many theories of trade that better help to understand
Russias current standing within the global oil industry, there are many
additional factors that contribute greatly to the success of the oil industry
as a whole and thus, must be discussed to obtain a thorough
understanding of the challenges faced (Matzke, 2007).
As previously mentioned, the price of oil is heavily dependent upon the
laws of supply and demand. Baring this in mind, there are many factors
both economically and politically that will largely affect the oil industry
and particularly the price of oil throughout the supply chain. Despite a
positive correlation in oil prices for many decades now, there have been
many major events in recent times that profoundly affected the oil
markets (Golembiovsky & Baryshnikov, 2006).
Like many other commodities, crude oil is traded on various world
markets. The earlier mentioned upward trend in oil prices have been
driven mainly by a steady increase in the demand for oil worldwide,
however, fluctuations in the price of oil are also clearly linked to political
factors such as instability in major oil producing nations. These countries
that experience the lack stability often do so because of political unrest
like in Venezuela, or war such as that of the Iraq war. Disruption of

distribution of production due to these factors can send a ripple effect

that can be seen globally (Golembiovsky & Baryshnikov, 2006).
Furthermore, other political factors that contribute to variations in oil
prices include government regulations; trade sanctions, embargos and
quotas, such as those imposed by OPEC, as well as sanctions imposed
upon Iran recently, a key player in oil production worldwide (Matzke,
2007). To give an example of government regulations affecting oil
markets, in 2007 changes made to the federal energy legislation caused
oil refineries to create cleaner blends of gasoline than what was
previously being produced. Because formulas had to be adjusted, supply
of gasoline was dramatically reduced whilst the changes were
implemented. Also, it must be remembered that taxes and fees
introduced by governments will undoubtedly cause a change in supply
and demand (Golembiovsky & Baryshnikov, 2006).
In terms of economical factors that affect oil markets, overall economic
uncertainty caused by poor economic performance, high levels of
unemployment or on the contrary high economic performance will all
affect supply and demand. When the economy is performing poorly,
companies and individuals have less disposable income, and therefore
demand for oil of all kinds is dramatically reduced as drastic measures
are made to keep costs down both at a macro and micro level (Matzke,
2007). When more cash is available, oil companies are able to produce
more, and consumers are able to use as much as they want. All of these
factors will cause major adjustments to supply and demand of oil
(Gurkov, 2010).
Performance, Efficiency and Factors of Mobility
In terms of Russia as well as Lukoil, competitive advantage is key in
determining the level of success that Russian oil will have on the world
markets. However, the fact that Russia does hold much greater
quantities of reserves than other oil producing nations does not
automatically insure success (Firlej, 2009). Due to overall globalization
of the oil industry, the ability of Russian oil companies to operate at a
level of efficiency that matches that of foreign competitors is the
difference between sinking and swimming. Currently, much of the
Russian oil industry lacks in terms of the level of technology used during
the production process of oil, compared to many of the foreign markets.
Although steps have been taken to bridge the gap between its

competitors, Russia has to do more in order to remain competitive. If a

certain level of efficiency is not obtained, the door will be left wide open
for competitors from abroad to directly invest into operations in the
Russian oil market, enabling them to acquire a huge market share of oil
sales within Russia, and on a larger scale, to exploit the supply of oil
available within Russia to serve the markets of the entire globe (Matzke,
2007).
Efficiency is not only a consideration in the manufacturing process of the
oil, but as much so in the distribution of the product (Poussenkova,
2010). Overall, there are many factors that contribute greatly to the
processes involved with the extraction and refining of oil products,
namely these include physical capital and human capital. The nature of
the oil industries requires that huge amounts of this capital be used in
order to take the product from its natural state all the way up until it
reaches the end user (Poussenkova, 2010). Because of the money
involved with oil production, investment is going to be most prominent in
locations that are going to yield the greatest efficiency and profit margin.
Due to the global demand for oil products, companies such as Lukoil
look to efficiently distribute products to foreign markets by production
sites that are geographically closer than their main reserves within the
home borders (Matzke, 2007). Because of the expense involved with
transporting dense materials such as oil, as well as the inherent
dangers, it is more profitable and viable for a company such as Lukoil to
meet a foreign customers needs with oil sourced from its holdings at a
location closer to the end user. Thus, for Lukoil to maintain an
acceptable profit margin without incurring large transportations costs,
production and distribution has to strategically planned and executed in
order to maintain an acceptable level of efficiency throughout the
distribution process (Gurkov, 2010).
Conclusion
To conclude, there are hurdles that stand in the way of success in the oil
industry. Political and economical factors are always going to largely
affect oil producers regardless of where they originate (Poussenkova,
2010). As for Russia and companies such as Lukoil, the key to success
and competing with other major players throughout the world lies in
efficiency - efficiency in extraction, refining and distribution (Gurkov,
2010). If a company is unable to invest in capital that increases
efficiency to a level close to that of its competitors, not only will it lose all

competitive advantage gained from vast oil reserves, but it will likely be
at threat from foreign prey, looking to exploit natural resources they only
wished they could have inherited (Firlej, 2009).
References
Firlej, K. (2009). Lukoil's Global Energy Reach: is the Russian Oil Giant
a Solid Investment?. Journal Of Case Research In Business &
Economics, 11-6. Retrieved on February 23, 2012, from Business
Source Complete.
Golembiovsky, D. D., & Baryshnikov, I. I. (2006). VOLATILITY SMILE AT
THE RUSSIAN OPTION MARKET.Journal Of Business Economics &
Management, 7(1), 9-15. Retrieved on February 24, 2012, from
Ebscohost.
Gurkov, I. (2010). Strategy techniques for the times of high
uncertainty. Journal For East European Management Studies, 15(2),
177-186. Retrieved on February 24, 2012, from Business Source
Complete.
Matzke, R. H. (2007). Russia and the United States: No Longer Rivals,
Not Yet Partners. Demokratizatsiya,15(4), 371-378. Retrieved on
February 22, 2012, from Academic Search Complete.
Poussenkova, N. (2010). THE GLOBAL EXPANSION OF RUSSIA'S
ENERGY GIANTS. Journal Of International Affairs, 63(2), 103-124.
Retrieved on February 23, 2012, from Ebscohost.

Botagoz.tulegenova@gmail.com