Is BP Playing Russian Roulette For Arctic Oil?

 

BP’s quest to drill for oil in Russia’s arctic region has thus far been a roller coaster ride of corporate cobwebs and political power plays. Yet despite facing incredible difficulties in pursuing Russian ventures, BP is clearly convinced that the stakes are high enough and the likely returns strong enough to make the hassle worthwhile.

 

 

BP’s quest to drill for oil in Russia’s arctic region has thus far been a roller coaster ride of corporate cobwebs and political power plays. Yet despite facing incredible difficulties in pursuing Russian ventures, BP is clearly convinced that the stakes are high enough and the likely returns strong enough to make the hassle worthwhile.

Despite the high profile disaster of the Gulf of Mexico spill, BP is one of the cannier and more sophisticated players on the global scene. Yet even a company as sophisticated as BP has so far found doing business in Russia something of a roller coaster ride. To date, the company’s experience with the state oil company Rosneft, and with the troika of billionaires who run the AAR consortium (joint partner with BP in its fractious TKN-BP venture) has been frustrating to say the least. It is perhaps important to realize that BP’s TKN venture has been a very serious, decade long play, accounting for some 20-25 percent of BP’s output and reserves, and making BP the only serious, large scale foreign oil company in Russia – until very recently that is.

Relations between BP and AAR have been difficult for years and soured further when AAR went to court in 2011 to stop BP forging ahead with a joint Arctic venture with Rosneft, on the grounds that such a venture would adversely impact the TKN-BP venture. TKN-BP is the third largest oil producer in Russia and has been a source of both profit and pain to BP since its launch a decade ago. The company was formed when BP merged its Russian energy business with AAR (Alfa Access Renova). In recent days AAR billionaire Mikhail Fridman has been quoted as saying that TKN-BP’s relationship with BP had “run its course”.

BP has been willing to sell its share to AAR, but while AAR wants to raise its stake in TKN-BP, it doesn’t want the whole of BP’s 50 percent. Now it seems that BP and Rosneft have the basis of a deal which will leave Rosneft as AAR’s new partner. Whether the deal will reopen the door to BP on the Arctic oil front remains to be seen. Three other oil majors have slipped in and signed deals while BP has been busy.

Related: BP’s Dudley Screws Up Russian Arctic Oil Deal

Related: Black Ice: The Dangerous Race For Oil At The Top Of The World

Russia’s Own Arctic Roulette

The Russian government recently reformed its tax regime for oil generally and announced particular concessions for Arctic projects. In April this year, Prime Minister Vladimir Putin promised to scrap taxes on exports of oil from Arctic projects and indicated a willingness to consider opening up licensing to foreign oil companies. Statoil, Eni and Exxon Mobile were the first off the mark, easily beating BP to the deal table, thanks to the blocking action of AAR nixing BP’s proposed Arctic E&P joint venture with Rosneft. Putin is insisting that all Arctic projects remain under Russian control, but JVs (joint-ventures) are definitely on.

At the time Putin’s spokesperson said that the tax incentives the government was putting in place would open the way for some $500 billion of investment in offshore energy projects over the next 30 years. However, things can change, and not necessarily for the better, and oil majors may well find a few years down the track that the tax deals that made the projects viable in 2012, have been reversed. As General Risk Assessment notes:

[quote]”Russian policy has gone through cycles of openness to foreign investment and then drawing back. The current phase is one of the most open in the last 20 years but it is far from certain that it will last for an extended period. Foreign investors might be vulnerable to a sharp deterioration in US-Russian relations – over, for instance, America’s plan to build in Europe an anti-ballistic missile shield against Iran – or a capricious policy shift in the Kremlin.”[/quote]

The initial deals are for exploration only. Given the remoteness of the fields and the prodigious cost of developing them, Rosneft and its partners will have to discover huge reserves in order to justify bringing the oil on stream. And if they do, Rosneft might be inclined to renegotiate the terms — especially if its expectations of expansion overseas have not been realized.

For Russia, the risk is that its international oil company partners might opt to press ahead with other projects first, if better opportunities emerge. On the basis of currently available information, it seems likely that offshore projects in Brazil, West Africa, and East Africa will be more profitable to develop than those in the Russian Arctic.

Related: A New Russian Empire: What Exactly Is Putin Planning?

Related: Kremlin Intrigues: Russian Economic Reforms or Clan Purges?

BP in Russia: Back in Play?

The waters have become so muddy in British oil giant BP’s long running battle with its troika of oligarch partners in TKN-BP, Russia’s third largest oil company – that it is all too easy to allow the details of the coming divorce between the parties to divert attention from the larger move, namely the next phase of BP’s long dance with Russia’s number one oil company, Rosneft. This move is also likely to put BP, once again, in a favorable position to benefit from the coming lucrative – and highly dangerous – opening up of massive Arctic oil reserves.

Irrespective of how the sale of BP’s stake in TKN-BP pans out, following a meeting with Vladimir Putin, BP has got the green light to use its stake money from the sale to buy a significant chunk of Rosneft. If Rosneft is successful in the bid for BP’s TKN-BP stake, it is said to be ready to provide BP with a share swap amounting to 12.5 percent of Rosneft shares, to add to BP’s existing 1.3 percent stake. The sale of TKN-BP is no small thing for BP. The venture is said to provide BP with almost a third of its total crude production and some 10 percent of its net income. It needs the deal with Rosneft to plug what would otherwise be a very large hole in its income and proven reserves holdings.

There is an extraordinary general meeting of Rosneft shareholders scheduled for 30 November, which should shed a good deal of light on where things are going. Rosneft is reported to have amassed a war chest of US$15 billion from banks to fund the purchase, and is expected to throw in some $10 billion in shares as well, since TKN-BP is currently valued at around $50 billion. A good chunk of that purchase price would, however, return to Rosneft as BP buys in to Russia’s number one oil company.

So why is Russia, which has been pretty keen to keep its oil champions Russian, now so interested in foreign inflows into the oil sector? It is not just BP. Putin has made it clear that he is throwing open the doors to foreign joint participation ventures. Exxon Mobile has already bought in to a Kara Sea exploration and production deal – the very one that BP was discussing with Rosneft last year – and Norway’s Statoil and Italy’s ENI also have significant ventures in hand. The basic reason is that Russia’s policy of using the oil and gas sector as a cash cow to support the modernisation of its economy has resulted in a tax regime that has starved the sector of capital expenditure.

[quote]An analysis of what this flight of cap ex from the sector would mean to Russia’s ability to remain the world’s number one oil producer – it is now ahead of Saudi Arabia – is said to have woken the Kremlin up to some harsh realities. Russia needs the capital and management/development expertise of western oil companies to keep the oil flowing. At bottom, it is as simple as that. [/quote]

As a final note, one should never forget that Rosneft as a company is the result of Putin’s astonishing and piratical “land grab” of Yukos, which had been Russia’s largest oil company from 2001 to 2005. That act of lawlessness saw the Russian State jailing Yukos CEO Michael Khodorkovsky and nationalizing the company on the grounds that Khodorkovsky had been cheating the State out of tax revenues due. Putin’s thumb was said to be heavily on the scales when Khordorkovsky’s appeal against his prison sentence was rejected last year.

In a Viewpoint for QFinance, Brian Misamore, the former financial director of Yukos was asked what his advice would be for anyone from a developed market who was offered a senior management position in Russia. He replied: “I would not want to share my talents with Russia today because the situation there is far, far different from what it was like when I went there in 2001. Until the Russian government explicitly supports transparency in its businesses and gets a handle on government corruption, I don’t think anyone should waste their time in Russia. There’s currently no sign of that happening.”

Yet despite its own difficulties in pursuing Russian ventures, BP is clearly convinced that the stakes are high enough and the likely returns strong enough to make the hassle worthwhile. Time will tell if it is right. 

By Anthony Harrington

Anthony Harrington is an award-winning business and energy journalist, writing regularly for the Scotsman newspaper, the Glasgow Herald newspaper, Financial Director magazine, Pensions Insight magazine, CA Magazine, and a number of other publications. He won Business Finance Journalist of the Year 2006, Institute of Financial Accountants, and Journalist of the Year, State Street 2006 Institutional Press Awards, and was runner up in 2007 and 2008.

BP Looks For A Second Bite At The Arctic Part One & Part Two is republished with permission from the QFinance Blog. Get the QFinance Dictionary of Business and Finance iOS app for a comprehensive guide to financial terms and expressions.