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Russia ‘Off Limits’ to Big Oil After BP Wins Putin’s Approval

By Joe Carroll and Edward Klump on October 22, 2012

Now that BP Plc (BP/) has partnered with Russia’s Vladimir Putin to oversee the world’s second-biggest oil industry, other international energy companies such as Exxon Mobil Corp. (XOM) and Royal Dutch Shell Plc (RDSA) are facing dwindling access to one of the last untapped troves of crude.

BP’s agreement yesterday to sell its half of Moscow-based TNK-BP to Russia’s state-run oil company, OAO Rosneft (ROSN), for $12.3 billion in cash and almost one-fifth of Rosneft’s shares vaulted the U.K. energy producer to preeminence among foreign drillers in the Russian oil patch, said Pavel Molchanov, an analyst at Raymond James & Associates Inc. in Houston.

Although other explorers may yet strike deals to search Russia’s vast untapped reserves, none will be able to replicate BP’s “seal of approval” from Russian President Putin, or match the London-based company’s access to powerful deputies such as Rosneft boss Igor Sechin, Molchanov said in an interview yesterday. Even as Exxon and Rosneft proceed with a $3.2 billion Arctic and Black Sea drilling venture signed last year, future contracts of similar scope are out of the question for outsiders, he said.

“For foreign oil companies seeking to expand production and reserves, Russia is now off limits,” Robbert Van Batenburg, head of research at Louis Capital Markets LP in New York, said in a telephone interview yesterday. The BP accord “is probably scaring the others away.”

Tightening Control

Russia, which increased its crude reserves more than any other nation except Iraq last year, has been a magnet for investment by Western oil companies since the early 1990s, when the collapse of the Soviet Union loosened state control of oil fields from the Ural Mountains to the Pacific Ocean. Russia is the source of one of every eight barrels of crude produced worldwide, second only to Saudi Arabia, according to the BP Statistical Review, an annual compendium of global energy data.

Since 2004, Putin has been tightening the government’s grip on the Russian oil sector, moves that made it increasingly difficult for foreign producers to establish or maintain footholds in the country, said William J. Andrews, a fund manager at C.S. McKee & Co. in Pittsburgh. Buying TNK-BP from the London-based producer and the Russian billionaires who own the other half will transfer to Rosneft fields that accounted for about 25 percent of BP’s annual output worldwide.

“The Russians are nationalistic and are going to keep the oil reserves for themselves,” said Andrews, who helps manage $14 billion. “They don’t really have a legal system or a political system. It’s a dictatorship.”

Principal Partner

Under the terms of the agreement announced yesterday, BP will receive $17.1 billion in cash and a 12.8 percent stake in Rosneft in exchange for 50 percent of TNK-BP, a 9-year-old venture of the U.K. company and an entity known as AAR that is controlled by the billionaires. BP plans to reinvest $4.8 billion of the cash in the government’s share of Rosneft, boosting BP’s holding to 19.75 percent. BP also will receive two Rosneft board seats.

“By signing this deal, the highest levels of the Russian government, up to and including Vladimir Putin, are endorsing BP as the principal western partner of the Russian oil and gas industry,” Molchanov said. “This is a big, big seal of approval for BP by Moscow and it means no other company is going to have access to the corridors of power like BP does.”

Exxon, the world’s largest (XOM) energy company by market value, and other international oil companies have been struggling to reverse production declines as fields discovered decades ago peter out and access to state-controlled reserves is denied or made onerously expensive from Latin America to the Middle East.

Shrinking Production

Exxon’s global output slipped for a fourth straight quarter during the April-to-June period, reaching the equivalent of 4.15 million barrels of oil a day, the lowest in two years, according to data compiled by Bloomberg. Exxon’s reserve growth slowed to 0.5 percent last year after jumping 7.9 percent and 8.9 percent in 2010 and 2009, respectively.

Shell’s production has declined in eight of the past nine years, and The Hague-based company’s costs to find untapped crude more than tripled in the past half decade, according to data compiled by Bloomberg.

Chevron Corp. (CVX)’s global output (CVX) dropped by 2.6 percent during the April-to-June period to the equivalent of 2.62 million barrels a day, the lowest second-quarter average since 2008, according to data compiled by Bloomberg. The San Ramon, California-based company’s reserves are 4.5 percent lower than a decade ago.

State Control

“The vast majority of the oil produced in the world is owned by state-owned companies, and that concentration is increasing,” said Bernard Weinstein, associate director of the Maguire Energy Institute in the Cox School of Business at Southern Methodist University of Dallas. “With this consolidation, you’re going to have one company dominating the whole Russian energy sector.”

Alan Jeffers, a spokesman for Irving, Texas-based Exxon, didn’t immediately respond to a phone message or e-mail seeking comment.

Chief Executive Officer Rex Tillerson spent almost $40 billion during the past 28 months to acquire North American shale fields and the expertise to harvest them. The most recent deals included this month’s C$2.86 billion ($2.88 billion) purchase of Calgary-based Celtic Exploration Ltd. (CLT) and a September agreement to buy Denbury Resources Inc. (DNR)’s North Dakota and Montana drilling rights for $2 billion.

Exxon’s partnerships in Russia include the Arctic and Black Sea exploration venture announced in February 2011, as well as the Sakhalin Island oil project in the country’s Far East that dates back to the early 1990s. Rosneft is a partner in both projects.

Limited Opportunities

Shell, the largest European energy company by market value, had control of a separate Sakhalin Island project wrestled away by Russia’s state-controlled natural gas monopoly OAO Gazprom (OGZD) in 2007 amid disputes over rising costs and environmental lapses. Shell retained a 27.5 percent interest.

“Ten years ago, Russia was a much more open place to do business,” Molchanov said. “But that is no longer the case, thanks to Vladimir Putin. The international oil companies are having to look elsewhere for opportunities at a time when the set of opportunities is growing more limited and costly.”

To contact the reporter on this story: Joe Carroll in Chicago at [email protected]

To contact the editor responsible for this story: Susan Warren at [email protected]

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