Analysis: When BP invested $6.7 billion to buy a 50 percent stake in a Russian oil company this month, it took many in the oil and gas industry by surprise.
Now the scramble has begun to place the deal in a larger context. Is it a one-off arrangement by a major Western oil company seeking to reposition itself to compete with the biggest multinationals on the global scene? This new Russian production, when added to BP's existing base, creates a company with volumes the size of Royal Dutch Shell with the two second only to ExxonMobil.
Or, does this event signal the start of Western money flooding into the Russian oilpatch as multinational companies seek to gather their rosebuds while they may? Oil and gas, after all, tends to operate with a herd mentality, particularly when it comes to mergers and acquisitions. The sea-change recombinations of ExxonMobil, ChevronTexaco, and ConocoPhillips came about in roughly 18 months.
With apologies to Winston Churchill, Russian business has been a riddle, wrapped in a mystery, hidden in an enigma. While it is easy to invest money into Russian oil firms, it is another thing to get money out. And BP can speak from first-hand experience why this is so.
First, it may be best to envision the Russian oilpatch as two separate entities. There are the massive crude oil deposits in western Siberia where large Russian oil firms hold sway. It is not likely that Western oil companies will ever get independent direct access to actual oil in the ground in western Siberia.
Then there is the Russian frontier, or new areas of oil and gas deposits, located in the Siberian arctic or the Far East where isolation and technical challenge provide Western multinationals an opportunity for entrée. As an example of the latter, think of the two competing multibillion-dollar developments underway on Sakhalin Island under consortiums directed by Western multinationals. Each will provide both oil and gas to other countries in the Far East, including Japan and Korea.
BP's investment this month indicates how Western firms can find opportunity in the western Siberian oilpatch. BP's $6.5 billion investment in TNK created Russia's third-largest oil company. In 1997, BP was one of the first to invest in the Russian oilpatch, providing $500 million for a 10 percent share in Sidanco, a company that operated in the best Russian business traditions following privatization of state-owned assets after the collapse of the Soviet Union.
The business model was quite simple. A handful of oligarchs essentially acquired state-owned assets for less than pennies on the dollar. Assets vanished, shareholders suffered dizzying dilution, and managers ran up huge debts as part of the looting process. Many of these companies dissolved in bankruptcy. This business model is one of the reasons underlying the Russian financial collapse in 1998.
Sidanco was no different. BP found assets mysteriously disappeared. And when Sidanco fell into bankruptcy, a rival company, Tyumen Oil, ended up with a significant part of Sidanco's oil assets through the Russian court system. BP wrote off $200 million for the educational tutoring.
But BP learned from its experience. The latest BP deal involves a partnership with Tyumen Oil and includes the original Sidanco assets plus adds one more company, Onaco, to create TNK, the third largest Russian oil firm. BP will end up with a 50 percent share, appoint the company's management teams and half of the board of directors, and become the first Western company to have a significant input into how a major Russian energy company operates. If issues develop, BP has created a mechanism where they will be arbitrated in Sweden while British law will govern shareholder disputes. Essentially, BP has adapted to doing business in Russia.
How that business model extends to other multinationals will be an interesting process. One thing that makes Russia attractive for Western investment is that petroleum assets are cheaply valued. Russian reserves had been trading for well under $1 per barrel (bbl) versus about $5 in the West. One analysis said the BP deal represented $2.60 per bbl of reserves. Another analysis placed the deal at $1.70 per bbl of reserves and $50 per bbl of production versus the normal Russian trading range of $25 to $40 per bbl of production.
The new entity will generate 1.2 million barrels per day (mmbbls/d) with reserves of 5.2 billion barrels. The entity will also own five refineries and 2,100 filling stations. BP generates 3.5 mmbbls/d currently.
Rival Russian oil firms liked the deal because of the value benchmark it created for their own holdings. But many nationalistic Russians in government and industry remain hostile to any direct Western investment in Russian business.
That may be why the BP deal fits the preference of existing Russian oil companies open to outside capital who can tolerate direct, noncontrolling investment in their own firms but oppose any competing investments in Russian reserves.
Western firms traditionally preferred Production Sharing Agreements (PSAs) for their foreign ventures because they provide stable tax regimes, define who owns what, and generate dollar revenues through an exportable product such as oil, thus protecting partners from currency fluctuations. In a sense, PSAs give Western firms direct access to foreign petroleum assets.
But PSAs are of little interest to Russian oil firms. Because of capacity constraints on exports, many of these giant oil companies make money through internal deals and exploitation of inter-regional market dynamics. They are not interested in the transparency that PSAs bring to the table.
A complex array of legislative reform that would allow for PSAs likely will remain stalled in the Russian Duma for some time to come.
Russian firms have developed local contact arrangements with magistrates, taxing jurisdictions, or other authoritative groups at the local and regional level that enable them to navigate the Byzantine world of Russian business. It would be challenging for Western oil firms to develop similar resources, or achieve any reception other than open hostility.
On the other hand, Russian firms are beginning to realize that the financial resources of Western multinationals provide a quick injection of needed, inexpensive capital that can underwrite expansion both internally and internationally.
As for the magnitude of the deal, consider that BP's investment represents 1.5 percent of Russia's GDP and represents one-third of the foreign capital invested since 1992.
But the answer to the question of whether this is a one-off deal or the start of a new trend may be implied from BP's conference call on fourth quarter earnings. The company is facing the same challenges all multinationals are seeing. Namely, long-lived properties in the U.S., North Sea, and Alaska are maturing. BP plans to invest up to $20 billion over the next five years in several profit centers, including the deepwater U.S. Gulf, Trinidad, Angola, Azerbaijan, and the Asian Pacific.
Russia makes the sixth profit center for the company. We'll know in a decade.
Associate Editor: Robin Beckwith
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