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From Russian Oligarch to Oil Kingpin

In an industry and a country equally smitten with size, the merger between Russia's two fastest-growing oil producers, Yukos and Sibneft, is surely one for the history books. Newly created YukosSibneft Oil Co., with a market capitalization of $35 billion, will rank as the world's fourth-largest oil producer, with current output of 2.3 million barrels per day. It will also be the third-largest holder of oil and gas reserves, behind Exxon Mobil Corp. and Royal/Dutch Shell Group. A privately owned Russian major, boasting production costs half those of ExxonMobil, has arrived on the world oil stage -- little more than a decade after the collapse of the Soviet Union and in defiance of predictions that the nation's infamous oil oligarchs were too fractious to pool together the holdings they snagged in the murky privatization auctions in the 1990s.

At a tactical level, the deal can be seen as a strike by Mikhail B. Khodorkovsky, the 39-year-old chairman of Yukos, Russia's second-biggest oil producer, to acquire No. 5 Sibneft before covetous Western oil majors did. His courtship began in earnest in February, after Anglo-American energy giant BP PLC hooked up with Moscow-based Tyumen Oil Co. (TNK) to take a 50% stake in a newly created Russian oil major, TNK-BP. Eager to match BP's play in one of the world's last remaining underdeveloped energy patches, competitors Royal/Dutch Shell and TotalFinaElf began pursuing Sibneft, according to Moscow industry sources. Both Shell and Total declined to comment.

But foreign oil ventures in Russia tend to move like molasses, with Westerners understandably skittish about the country's still-perilous business climate. In contrast, Khodorkovsky, who had explored a merger with Sibneft back in 1998, was able to pounce. The bargaining ended with Yukos agreeing on Apr. 22 to pay Sibneft's core shareholder group, led by business baron Roman Abramovich, $3 billion in cash plus sufficient shares in YukosSibneft to give the group a stake of more than 25%. Slated to become CEO of the company, Khodorkovsky, a onetime activist in the Communist Youth League, now stands as the undisputed king of Russian capitalism.

Not that he won't be challenged. With this deal done, YukosSibneft and TNK-BP are likely to compete for smaller players. "This deal is a sign for other Russian oil companies to think about a merger," says Mikhail Fridman, chairman of TNK-BP.

YukosSibneft, with plans to devote $2.9 billion to capital expenditures this year, will certainly have the resources to pursue energy ventures outside of Russia. But the company's main competitive advantage lies at home. YukosSibneft will be well positioned to bid on state-held licenses for the vast tracts of undeveloped fields in East Siberia and elsewhere.

The new company plans to boost oil production by at least 20% annually. "The big growth potential of YukosSibneft is here, in Russia," says Moscow investment fund manager Mattias Westman of Prosperity Capital Management Ltd., a holder of shares in both Yukos and Sibneft. The market seems to like the deal: Yukos shares rose 8% in trading after the merger's announcement.

Even as he burrows deeper into Russia's stores of black gold, Khodorkovsky will be looking for more export routes out of the country. The existing pipeline network operates at 99% capacity, limiting Russian oil exports to 4 million bbl. per day. A likely top priority for YukosSibneft is building a pipeline to the port of Murmansk that would sharply reduce the cost of transporting oil to the U.S. For Russia, "the most important relationship is with America," Khodorkovsky told BusinessWeek in March.

For Western majors unhappy that Yukos got to Sibneft first, there may still be the possibility of a strategic partnership with the new Russian titan in a year or two. Khodorkovsky says he wants to retire from the oil business altogether by 2007, and as this deal shows, he is hardly adverse to bold plays. For Russia's most dynamic industry -- and its most visionary tycoon -- these are early days. By Paul Starobin in Moscow

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