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The Wall Street Journal: BP’s Rosneft Bid Shows Need to Please in Russia

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Offer for 9% Stake
Seen as Way to Keep
Standing in Nation
By GUY CHAZAN
March 28, 2007; Page A10

MOSCOW — A decision by BP PLC’s Russian joint venture to take part in a contentious auction for Russian oil assets shows the lengths BP is prepared to go to protect its landmark Russian investment, industry observers say.

The auction concerned a 9% stake in OAO Rosneft, the state oil company. BP’s Russian joint venture, TNK-BP, offered $7.58 billion but lost out to Rosneft itself, one of two state energy companies whose goodwill could be critical for BP’s future in Russia. The auction required two bidders to go ahead. Rosneft won the stake for $7.60 billion.
 
“It appears BP was trying to curry favor with the Kremlin and Rosneft by conferring legitimacy on the auction,” said Ivan Mazalov at Moscow-based Prosperity Capital Management, a minority shareholder in TNK-BP.

TNK-BP and Rosneft dispute that, with TNK-BP saying it competed in earnest for the stake and bowed out only when the price got too high. A BP spokesman referred questions to TNK-BP.

The BP joint venture’s involvement was surprising to many in the industry because the stake had been held by OAO Yukos, a former Russian oil giant broken up by the Kremlin in a move criticized by many Western governments. The authorities’ dismantling of Yukos was widely seen as punishment for the political ambitions of its founder, Mikhail Khodorkovsky, who is now serving eight years in prison for fraud and tax evasion.

It was in 2003 that BP’s chief executive, Lord John Browne, made his big bet on Russia, investing $7.7 billion in a 50-50 tie-up with local oil company TNK International. At the time, Russia — home of some of the world’s largest reserves of oil and natural gas — appeared open for business, and BP’s success was seen as a harbinger of major deals to come.

It turned out to be the high-water mark of foreign involvement in Russian oil. Since then, the Kremlin has changed the rules substantially: State energy giants Rosneft and OAO Gazprom now dominate, with foreign companies relegated to the status of junior partners.
 
The latest victim of the new trend was Royal Dutch Shell PLC, which last year was forced to cede Gazprom a majority stake in a $22 billion oil and gas project on Sakhalin Island in Russia’s Far East after pressure from regulators threatened to shut it down.

These days, TNK-BP — the only big Russian oil company with 50% foreign ownership and no government involvement — sticks out like a sore thumb.

Still recovering from a string of setbacks in the U.S., BP faces nail-biting times in Russia. Authorities are threatening to pull the license of a huge gas field it owns in Siberia, and speculation is rising that the Russian shareholders in TNK-BP are coming under pressure to sell out to Rosneft or Gazprom.

Considering the dangers on the horizon, it was unsurprising that the first foreign statesman Lord Browne chose to introduce his successor Tony Hayward to was Vladimir Putin — the man whose blessing was crucial to the creation of TNK-BP and who now holds the venture’s fate in his hands.

Russia is central to BP’s strategy. TNK-BP accounts for 25% of the group’s total production and 12% of its post-tax profit, while 29% of BP’s booked oil reserves are now in Russia. “The venture is strategically important for BP’s future,” said Valery Nesterov, an oil analyst at Troika Dialog in Moscow. “That’s why it took part in today’s auction, despite the risks of litigation from Yukos shareholders.”

The immediate issue facing BP in Russia is regulatory pressure related to its vast Kovykta gas field, one of TNK-BP’s key Russian assets. Russian officials say TNK-BP has violated the terms of the license by failing to produce enough gas from the field — despite a dearth of local demand — and have given it until May to comply. Kovykta is one of Russia’s largest gas fields, thought to contain nearly as much gas as Norway.

TNK-BP has described the terms of the license as “outdated and unachievable.” Russian officials essentially agree, but have hinted that only by allowing state-run Gazprom to take a large stake at a price acceptable to the gas company can TNK-BP save the project.

Getting Kovykta right could be a huge opportunity for BP. Partnering with Gazprom, an outcome BP executives say they want, would allow the company to both retain a stake in the field and develop it. That is something none of its rivals have so far been able to achieve in Russia. Gazprom’s involvement would be critical to getting the gas to market in China.

But beyond Kovykta, uncertainty also surrounds the fate of the TNK-BP joint venture itself. Last year a senior Gazprom official said his company would be eager to buy out the Russian billionaires who currently own 50% of the company. They have repeatedly denied any desire to sell.

TNK-BP Chief Executive Robert Dudley last week dismissed speculation about changes to the company’s shareholding structure as “not true.” But some in the company seem to have resigned themselves to swapping their current Russian partners for Gazprom or Rosneft. A big fear is that BP’s stake would dip below 50%, costing it management control — the very factor that makes the venture so unique in today’s Russia.

Gazprom is seen more as an arm of the Russian state and an instrument of Kremlin foreign policy than as a commercial company, while Rosneft is more closely modeled on a classic Western oil major. BP already has a close relationship with Rosneft: It bought a $1 billion stake in Rosneft’s public offering last year, and the two are jointly developing two blocs north of Sakhalin Island.

Analysts said that it was looking more likely that Rosneft would end up owning the 50% Russian stake in TNK-BP, if any sale takes place. Finding the $20 billion or so to buy it would be a “stretch for Gazprom from a financial standpoint,” says UBS oil analyst Kaha Kiknavelidze, given that Gazprom must cough up $7.5 billion for the 51% stake it acquired in Sakhalin-2 last year and will also be bidding for the 20% stake in Gazprom Neft that will be sold at the next Yukos bankruptcy auction in April. That stake is expected to sell for around $4 billion.

TREADING CAREFULLY
 
•  The News: BP’s Russian joint venture bid and lost in an auction, a move industry observers say would help the venture politically.
 
•  The Backdrop: Russia has pressured other Western oil companies.
 
•  What’s Next: The venture faces regulatory pressure at a lucrative gas field.

Write to Guy Chazan at [email protected]

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