BP-Rosneft's plans on ice

Mar 28, 2011 12:00 AM

by Matt Atkins

In the first weeks of January troubled oil giant BP and Russian state-owned Rosneft announced a groundbreaking share-swap, in a deal that will see the firms work together as part of a strategic alliance. The move appeared to place BP, recovering from last year’s Gulf of Mexico oil spill, in a strong position to exploit untapped energy reserves in the Arctic, offsetting the $ 40 bn that the firm owes in costs for the summer’s environmental disaster.
However, despite the initial excitement, the joint venture has been threatened by existing business partners, adding to the pressure on an already beleaguered BP.

The deal
The deal, announced on 14 January, would see Rosneft hold 5 % of BP’s ordinary voting shares in exchange for 9.5 % of Rosneft’s shares. Completion of the agreement would mark the first major equity-linked partnership between a national and international oil company.
Rosneft, Russia’s leading oil producing company, produces some 2.4 mm boepd, and has reserves of 15.146 bn boe. Producing oil in all key regions of Russia, the firm reported profits of over $ 10 bn for 2010.
Its deal with BP has been welcomed by the Russian market and analysts believe it will boost Rosneft’s bid to become a global oil giant.

The share-swap is also a milestone in Russia’s economic relations with the West, and has been welcomed by the Russian government which encourages talks with foreign oil companies eager to bid.
“Global capital and Russian companies are clearly ready to invest in world class projects in Russia; and Russian companies are quickly emerging at the forefront of the global energy industry,” says Igor Sechin, Deputy Prime Minister of the Russian Federation.

BP is just one of the international oil firms with an interest in establishing contracts to develop Russia’s Arctic oil reserves. Its deal, which has drawn criticism from environmental campaigners, will see the companies explore in the Russian Arctic continental shelf and drill in the Kara Sea off Russia’s North Coast. Rosneft received the rights to develop three Kara Sea blocks, an area equivalent in size to the UK North Sea, in October of last year.
In spite of the environmental concerns about drilling in the Arctic, BP chief executive Robert Dudley said that the Gulf of Mexico spill had taught BP many harsh lessons. Indeed, Rosneft is expected to benefit from the expertise that BP gained in tackling the disaster, a fact which may have made the deal even more attractive.

The two companies had discussed an exploration venture over the past few years, according to Mr Dudley. But the decision to forge a closer alliance through a share-swap had only been considered in the past two to three months. It is believed in some quarters that BP held out on a transaction until its own share price improved.
Furthermore, it has been suggested that the share-swap resulted from BP’s fears that state-owned Rosneft planned to acquire its Russian subsidiary, TNK-BP with a view to a carve-up. These anxieties were aired by David Peattie, head of BP in Russia and an executive director of TNK-BP, and revealed in Wikileaks-released US embassy documents.

The deal has been something of a coup for Mr Dudley, who has met with Russia’s Prime Minister Vladimir Putin for the first time since taking the helm at BP in October 2010. Russia welcomed Mr Dudley’s appointment as chief executive, when his predecessor Tony Hayward stepped down.
This is despite a bitter dispute in 2008 that saw Mr Dudley flee the country. Russian investors, and the authorities, were displeased with his performance as chief executive of TNK-BP, of which Alfa-Access-Renova (AAR), a consortium of Russian oil tycoons, is the joint shareholder. Lord Robertson, the venture’s chairman, accused the Russian shareholders of carrying out a campaign of harassment against Mr Dudley which caused him visa problems and involved surveillance of staff. These claims were denied.

The difficulties
The difficulties of the TNK-BP venture have not gone quietly into the night, however, and the oligarchs behind AAR have raised objections to BP’s newest Russian deal. The consortium’s owners, Mikhail Friedman, Len Blatvatnik, German Kahn and Viktor Vekselberg, argue that the deal violates an earlier agreement, that BP’s dealings in Russia should go through TNK-BP, and that the firm should have been involved in the talks with Rosneft.
Details of the share-swap were kept secret because they were share price sensitive, claims Mr Dudley, and details of the Rosneft deal were sent to AAR, albeit almost two weeks after the deal was unveiled.

AAR claims that the documents contained no new information beyond what BP had already disclosed to the market. Mr Dudley says that TNK-BP, which accounts for 25 % of BP’s total production was not approached as a partner for exploration as it does not have the skills or expertise for offshore drilling.
BP initially indicated that it would pay compensation to the consortium, in exchange for their approval of the business venture. However, AAR made it clear that they would not be happy with such a settlement.

On 27 January, the businessmen filed for a temporary injunction at London’s High Court. Stressing that rather than wanting to derail the deal in its entirety, they wished for AAR to be brought in and TNK-BP to be the main vehicle for BP’s Russian operations.
The Court granted the injunction, ruling that BP’s deal with Rosneft cannot proceed until a United Nations arbitration under Swedish law is completed in London, with a final ruling.

Further speculation emerged on 4 February when it was reported that AAR was willing to sell its stake in TNK-BP to either Rosneft or the Russian government. These rumours were quashed when Rosneft head, Eduard Khudainatov, confirmed that the company would not enter into talks with the consortium.
Agreeing that an out-of-court settlement would be the ideal conclusion to the dispute, on 17 February the matter was put to TNK-BP’s board of independent directors. Under a shareholders’ agreement the TNK-BP board has right of review over BP’s other Russian activities.

“We will have to hire lawyers so we can have our own position on the matter,” said independent director Alexander Shokhin, chairman of the Russian Union of Industrialists and Entrepreneurs.
His fellow independent directors are former German Chancellor Gerhard Schröder and James Leng, a senior adviser to HSBC Holdings.

It was not just BP’s Russian partners that objected to the Rosneft venture. Distaste for the deal also came from the US. News of the proposed transaction came just days after a presidential commission published a damning report on the lead up to the deepwater disaster, and the US state department faced calls to investigate whether the Russian government’s links with BP posed national security issues.
“BP is one of the biggest suppliers to our military. Are there national security implications to this deal?” asked Michael Burgess, a Republican congressman sitting on the House energy and commerce committee. His objections revolved around the fact that BP runs sensitive trans-Alaskan oil pipelines and that the group’s BP America subsidiary is regulated as a US company.

The venture also drew criticism from Democrat Edward J. Markey who sits on the House natural resources committee. Markey called for a thorough analysis of the agreement referring to BP as “Bolshoi Petroleum”.
If the deal is found to affect the operations of BP America, he said, the committee on foreign investment in the US should analyse the deal.

Additional US pressure on BP came from another source. As the dispute between BP and its business partners grew, Rosneft struck another deal with the potential to shake BP’s confidence. On 27 January, the very day that AAR entered the courtroom, Rosneft sealed a $ 1 bn venture with ExxonMobil -- BP’s main US competition. That agreement would see the companies explore the Black Sea.
Though the US firm put up the entirety of the initial investment, the development will be 66 % owned by Rosneft and 33 % owned by ExxonMobil.

Conclusion
If BP’s 2011 hadn’t been disappointing enough, it was only made more disturbing by the announcement of its annual results on 1 February. The company made a loss of $ 4.9 bn for the year, its first loss for 19 years. The results were to be expected, however, as a consequence of the Gulf oil spill costs which have recently risen by $ 1 bn to $ 40.9 bn.
That said, the same day saw the firm announce a return to paying dividends, which were suspended at the peak of the Gulf of Mexico oil spill. BP said that it would pay a fourth quarter dividend of 7 cents per share.

The Rosneft deal can be seen as a change in BP’s strategy -- a legacy of the deepwater spill. BP is to sell half of its refining capacity in the US -- a wise move, some would say, given the feeling toward the oil giant in that area of the world -- and focus on exploration.
The refineries to be sold are Carson in California and Texas City, where 15 workers died in an explosion in 2005.

Mr Dudley has also pledged to scrap BP’s old production targets, promising a focus on quality rather than quantity. The firm also plans to restructure its downstream business -- the oil and gas operations which take place after the production phase -- and concentrate on growth in developing and emerging markets.
Providing its venture with Rosneft is not derailed, 2011 could see BP begin to put last year’s disaster behind it.

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