The Rush to Russia
The significance of the BP-Rosneft deal has not been sufficiently appreciated by mainstream media, argues energy analyst Matthew Hulbert. According to Hulbert, the agreement signals the start of a new M&A frenzy in the upstream sector, as international oil companies (IOC’s) are rapidly stepping up their attempts to realise joint-ventures with national oil companies (NOC’s). This rush to Russia and other resource-rich countries, he notes, is the direct result of the “Macondo” oil spill. ‘The disaster in the Gulf of Mexico has turned traditional notions of political risk on their head. Ironically, Russia is now deemed a safer and potentially more rewarding bet than a politically capricious country like the US.’
To say this hasn’t gone down well in DC would be an understatement. ‘Bolshoi Petroleum’ was the quip fired back from a US Congress still chafing from BP’s Macondo mishaps. It’s certainly a catchy label, but one that is ultimately wrong. This is a case of ‘Business Petroleum’ through and through. More likely than not, it will signal the start of an upstream M&A frenzy in the oil sector as ‘Big Oil’ has learnt ‘big lessons’ from the Gulf disaster: what were once deemed high risk markets are now fair game, and the supposed ‘safe bets’, such as the Gulf of Mexico, if not quite ‘toxic’, will be treated with caution. Working more closely with national champions is also the inevitable way of the future for IOCs that want to flourish and prosper. Indeed, this analysis has already been vindicated by subsequent events; both ExxonMobil and Shell have followed BP’s example in the past weeks and have announced their interest in cooperating with Rosneft.
If nothing else, the Rosneft deal demonstrates that BP deems Moscow to be a better, and indeed, more lucrative bet than Washington. This is a reality that popular media have failed to wake up to. They are still too busy wasting endless column inches bleating on about political risks pervading Russia. ‘News flash’ just in: BP knows that Russia is no bed of political roses – that’s precisely why it has upped its game and decided to deal directly with the Kremlin rather than keep walking the TNK-BP tightrope.
Call it a hedge on BP’s part if you like, but Russia is in no position to be playing hard and fast with upstream development right now, and BP knows it. Russian depletion rates all point towards the fact that Moscow will struggle to maintain output at the current level of above 10 million barrels per day
|The Rosneft deal demonstrates that BP deems Moscow to be a better, and indeed, more lucrative bet than Washington|
The initial blocs in question are said to hold as much oil and gas as the North Sea, which would be some 60 billion barrels of oil-equivalents. Igor Sechin, Russia’s Deputy Prime Minister and Chairman of Rosneft, even said that they may hold an estimated 5 billion tonnes (35 billion barrels) of oil and 10 trillion cubic meters of gas (63 billion barrels of oil equivalent), a total of 100bn barrels of oil equivalent. That would add a quarter to Russia’s already massive 44.4 trillion cubic metres of gas reserves and more than a third to its sizeable, if less impressive, oil reserves. But the only way to get at such phenomenal resources is through massive capital expenditures and technological edge, both of which BP is offering.
For now, Rosneft has taken a 5% stake in BP while the British company has upped its stake to 10.8% in the 75% state owned entity, which roughly equates to a US$7.8bn swap. BP will also be sinking $2bn into initial Arctic surveys. Further equity swaps should certainly not be ruled out between the two entities, nor should engagement from Gazprom on the gas side if potential reserves start to look rather juicy, particularly as the Kremlin has gone to great lengths to warn TNK that BP could, and indeed should, be doing business in Russia outside of the Alfa Acces Renova consortium. The fact that the Russian entity has had to turn to London’s High Court for legal redress against BP for the Rosneft deals suggests that
|BP knows that Russia is no bed of political roses - that’s precisely why it has upped its game and decided to deal directly with the Kremlin rather than keep walking the TNK-BP tightrope|
This all points to the fact that political risk is by no means dead in Russia: far from it. The closer Arctic fields come to production over the next decade, the more daunting the risks will become for BP. The ‘obsolescing bargain’ has far from ‘obsolesced’ when it comes to cutting IOCs out of the loop just at the critical moment; no one would be stupid enough to pretend otherwise. But the biggest risk in play now is not being there in the first place. Having drifted downstream over the years and dabbled in renewables, Big Oil is getting back to what it knows best – exploiting challenging upstream oil and gas resources. That is where the big profits will rest and where IOCs have to be if equity analysts are going to give them consistent ‘buy’ options.
Much of this is a direct result of Macondo. It was the consummate wake-up call for big oil to stop playing out time in politically capricious and developed markets and get back out into the ‘new world’ for the juiciest finds and highest returns. In effect, Macondo has turned traditional notions of political risk on its head. The alarm bells obviously rang loudest for BP given the swathes of oil blackening their hands.
|The Arctic thus really matters for Russia|
The upshot is that we can expect to see more offshore drilling across the board (with the ironic effect that BP will be leading the charge in regions spanning from the Gulf of Sidra to the Arctic and beyond). Indeed, no sooner had Dudley put pen to paper with Rosneft, than Exxon Mobil turned up to sign a $1 billion exploration deal with Rosneft in the Black Sea. It was the first time the American oil giant, the largest company in the world, committed itself to a major investment in Russia in more than a decade. ExxonMobil’s CEO Rex Tillerson signed the agreement with Rosneft’s Chairman Igor Sechin at the
|Under no scenario will TNK be allowed to stand in the way of Arctic exploration|
An important part of the explanation for the rush towards Russia is the well-known fact that the vast bulk of world oil reserves are strictly off limits for IOCs, most notably in the Middle East. Passing up Russia is a luxury no international company can afford. If anything, learning to work more closely with national entities now will come with considerable dividends in future. This logic applies as much to gas (where a little more IOC wiggle room persists) as it does for oil.
And this is not just about accessing indigenous reserves in Central Asia, Africa and Latin America. It also about striking joint ventures with NOC’s in third countries. BPs work with Chinese oil company CNPC in Iraq is one such example, but many more will need to follow if IOCs want to stand the ‘oil test of time’. Chinese (and to a lesser extent Indian) majors are not going to stop investing upstream until demand is sated. For them security of supply will always trump price. Either IOC’s get their act together,
|Passing up Russia is a luxury no international company can afford|
Getting in bed with NOCs is therefore the smart play for IOCs. No doubt this was due to necessity rather than choice as far as BP’s marriage to Rosneft is concerned, but it sends a clear message for other IOCs to follow. Having a big, bad ugly wife is better than having no wife at all. With oil set to become an increasingly dirty game in future, the lines between public and private will be inexorably blurred. In that sense, ‘Business Petroleum’ and ‘Bolshoi Petroleum’ aren’t that far removed after all.