World - Russia: A 21st Century Alliance?

Russia: A 21st Century Alliance?
Michael Bradshaw

BP and the Russian state controlled company Rosneft have announced a strategic global alliance that involves the first major equity-linked partnership between a national and international oil company. While the potential rewards are high, so are the risks. Is this really an 'alliance fit for the 21st Century'?

In BP's St James's Square headquarters on January 14 2011, the CEO of BP, Robert Dudley and the president of Rosneft, Eduard Khudainatov, under the gaze of Britain's Minister for Energy and Climate Change Chris Huhne and Russia's Deputy Prime Minister Igor Sechin - also Chairman of Rosneft's board - formalised their new alliance.

In June 2003, then Prime Minister Tony Blair and President Vladimir Putin witnessed the creation of a joint venture between BP and Russian oil company TNK (TNKK-BP), each holding a fifty percent share. This alliance has not been without its problems. The company still has unfinished business with natural gas extractor Gazprom over ownership of the Kovykya gas field in East Siberia, which could yet be sold to Rosneft. In 2008 there was serious conflict with TNK's owners that culminated in then CEO Robert Dudley having to leave Russia in difficult circumstances. Ironically, the disagreement was about BP's lack of international ambition for the company. In 2009, Russia accounted for 33 percent of its global oil production; thus BP is already more committed to Russia than any other InterOil Company (IOC). Now, in the face of adversity, BP has chosen to make a further substantial investment in Russia. Critics of BP see this as a desperate response provoked by its problems in the Gulf of Mexico; others see it as a prudent investment with long-term potential. There is an element of truth in both positions.

Terms Of The Deal

Under the alliance agreement, BP acquired a 9.5 percent stake in Rosneft and in return Rosneft is issued new BP shares giving it a five percent share in BP (valued at around 7.9 billion US dollars). This new agreement gives BP a total stake in Rosneft of 10.8 percent. The alliance will form a joint venture to explore three license blocks in the South Kara Sea, an area of 125,000 kilometres - about the size of the North Sea - in relatively shallow water. The area is the offshore extension of the West Siberian basin that is Russia's most important oil and gas region. According to the Russian Ministry of Natural Resources, the Kara Sea is estimated to have 37.4 percent of the hydrocarbon potential of Russia's continental shelf. Rosneft will own 66.7 percent of the venture and BP the remaining 33.3 percent; BP covers most of the initial 1-2 billion dollar exploration costs. This is clearly a major opportunity for BP but operating conditions will be extremely challenging as the area is only navigable one hundred days a year. In addition, the two companies will establish an Arctic technology centre in Russia and will seek further opportunities for international collaboration beyond their 50-50 joint venture partnership in Ruhr Oel GmbH in Germany.

This alliance is the result of an evolving long-term relationship between the two companies. The idea of a share swap is said to have originated from a meeting between Russian Deputy Prime Minister Igor Sechin and former CEO of BP Tony Hayward in Moscow last summer. Since 1998 the two companies have been working together on the Sakhalin-5 project, which has provided first hand experience of the challenges of exploration in Arctic-like conditions under Russian jurisdiction. The Sakhalin offshore is as much closer analogue to conditions in the Kara Sea than BP's experience in Alaska, which is largely onshore. In November 2006 they agreed to conduct joint studies to identify areas of mutual interest in the Russian Arctic. Through TNK-BP, they have also cooperated in the development of the Verkhnechonskoye field in Irkustk Oblast. The problem for TNK-BP is that the Russian government has given Gazprom and Rosneft monopoly over the development of the Arctic continental shelf. For BP, the choice of Rosneft was the natural choice as the evolution of an existing relationship.

Risks Before Reward

This is a long-term alliance; exploration activity will not begin before 2015 and, if successful, production will not start until well into the next decade. Those who doubt the wisdom of the alliance tend to focus on the risks, rather than the potential long-term rewards. Undoubtedly, there is the risk that this alliance will further tarnish BP's already damaged reputation by aligning it with a company that is not only controlled by the Putin camp in the Kremlin, but that owes its current status to the questionable acquisition of the assets of bankrupt petroleum company Yukos. Many liberal politicians and interest groups, in Russia and abroad, see the agreement as legitimising the Yukos case and the continued imprisonment of former Yukos president Mikhail Khodorkovsky. However, such risks were prevalent when BP participated in Rosneft's initial public offerings in London in 2006, which was controversial at the time; and they have not stopped Exxon Mobil from working with Rosneft on Sakhalin-1.

In aftermath of the Gulf of Mexico disaster, one could argue that the Russian Government is taking a risk by allowing BP to operate in the Arctic offshore. Their position is that BP has learnt a great deal from the Gulf of Mexico spill and that makes it a more environmentally responsible partner. The environmental NGOs do not share this optimism. Greenpeace, for example, points out that BP was not granted access to drilling concessions in offshore Greenland last year and the Chairman of the World Wildlife Fund in Russia warns that: 'Drilling in the Arctic will provoke massive resistance by green activists throughout the world.' Canada is currently reviewing offshore drilling operations and BP has formed a joint venture with Exxon Mobil to explore in Canada's Beaufort Sea. Environmental groups are rightly concerned by the challenges posed by remoteness and by oil spills under ice and would like to see a moratorium on Arctic drilling. American President Barack Obama's Commission on the Deepwater Horizon disaster is equally concerned about the environmental dangers of Arctic offshore exploration, yet Shell Oil Company plans to drill two wells in Alaska's Chukchi Sea this summer, having paid 2.1 billion dollars for exploration rights in 2008. The rush to gain the rights to explore for Arctic oil and gas is on and BP has stolen a march with this deal with Rosneft.

Through TNK-BP and its other operations in Russia, BP has first hand experience of the many problems of doing business in Russia, yet it states it has 'confidence in the Russian investment environment.' This is the same country that was ranked 143rd out of 179 countries in the Heritage Foundation's 2011 'Index of Economic Freedoms' and 123rd out of 183 countries in the World Bank's 2011 'Ease of Doing Business rankings.' The global economic crisis has hit Russia hard and there is much rhetoric about modernisation, but very little action. In September 2009, Prime Minister Vladimir Putin invited the heads of potential foreign investors to Salekhard in West Siberia to ask them to participate in the development of the Yamal gas fields. Russia's onshore oil and gas fields are fast depleting and Moscow finally recognises that foreign capital and technology will be required to open up new production in frontier regions. Putin has even promised the new alliance a tax structure that will be 'most conducive.' Meanwhile, the Ministry of Natural Resources is looking to streamline the complex bureaucracy that regulates offshore exploration. The structure of the proposed joint venture suggests that both sides have learnt from the experiences of Sakhalin-2. It is reported that BP will not own the reserves, though it hopes to be able to book them. The Russian partner retains control and ownership, but this does not mitigate against future appropriation.

In the face of criticism for attending the signing ceremony, a spokesperson for Chris Huhne maintained that: 'It is ultimately a deal between two companies.' Jeremy Huck, the head of BP's Russian operation, is quoted in the Moscow Times saying: 'We are businessmen, not politicians, we are here to conduct business.' The geopolitics of Russia's energy relations is far more complex than that. The deal has been met with hostility by some politicians in the United States, with one congressman labeling BP 'Bolshoi Petroleum', but Robert Dudley maintains that the alliance is not against American interests in anyway. Dudley is also of the opinion that the deal is good for global energy security, presumably because it will help Russia maintain its oil and gas exports; but by doing so it will also enrich the Russian state and allow it to continue its current ways.

Even before the Gulf of Mexico disaster, the challenge for BP was gaining access to new reserves of oil and gas. According to the US Energy Information Agency, in 2007 IOCs only had full access to six percent of the world's oil reserves. Consequently, for IOCs the future means partnering in some form or other with the national oil companies of reserve holding countries. The age of easy oil is over and entering into risky partnerships with unstable political regimes and in fragile and demanding natural environments to explore for oil and gas is what the 21st century oil business is about. In the eyes of many, this deal may not be fit for the 21st century, but it does demonstrate what will be necessary for companies like BP to satisfy our continuing addiction to oil and gas.

(Michael Bradshaw is a Professor of Human Geography at the University of Leicester.)