Exxon-Mobil and Russia's Rosneft Create Artic Oil and Gas Exploration

question 110

Essay

Exxon-Mobil and Russia's Rosneft Create Artic Oil and Gas Exploration Joint Venture
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Key Points
Contractual commitments in cross-border alliances are effective only to the extent they are enforced by each country's legal system.
The success of most alliances ultimately depends on the extent to which each partner needs the capabilities and resources of the other.
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Exxon-Mobil (Exxon) finalized an agreement with the government-owned Russian oil and gas giant Rosneft on April 16, 2012, to create a joint venture to explore for oil and gas in three designated areas in the Russian portion of the Artic Ocean known as the Kara Sea. The agreement superseded a similar but failed agreement with British Petroleum (BP) earlier in the year. Rosneft's attempt to strike a similar pact with BP in 2011 fell apart because the British company had a joint venture with a separate group of private Russian investors, which blocked the Rosneft deal in an international court. While BP had planned to swap stock, Exxon agreed to give Rosneft assets elsewhere in the world, including some that Exxon owns in the deep waters of the Gulf of Mexico and in Texas. Future investments could total tens of billions of dollars. The final agreement was contingent on Russia's reducing taxes imposed on oil and gas companies.
The U.S. Geological Survey estimates that the Artic holds one-fifth of the world's undiscovered, recoverable oil and natural gas. The Kara Sea has an estimated 36 billion barrels of recoverable oil reserves. Total oil and gas reserves are estimated to be 110 billion barrels of oil equivalent, four times Exxon's proven worldwide reserves. Drilling is expected to start in 2015, with Exxon shouldering most of the costs. In exchange for access to these Rosneft properties, the agreement gives Rosneft an option to invest in certain U.S. properties. Rosneft will own two-thirds and Exxon the remainder of the joint venture. The initial commitment by the two companies is to invest $3.2 billion in exploration in the Kara Sea.
As a world leader in Artic exploration, Exxon is willing to share its expertise with Rosneft, as well as to transfer technology, in exchange for access to Russia's Artic region. The Russians are particularly interested in learning the latest techniques employed in hydraulic fracturing (so-called "fracking") of underground oil and gas deposits trapped in shale rock. This deal also allows the Russian petroleum industry to diversify internationally. While Russia currently pumps more oil than Saudi Arabia, its onshore oil fields are in decline, threatening a major source of Russian export revenue. Furthermore, Rosneft receives an option to acquire an equity interest in certain Exxon projects in North America, including deep-water drilling in the Gulf of Mexico and fields in Texas. In addition, Rosneft will have an opportunity to invest in Exxon properties and projects outside of the United States. Granting Rosneft options to invest in certain Exxon assets was an important precondition for getting agreement on the joint venture.
The Russian government had long demanded reciprocity as part of any deal. This required that in exchange for any ownership in Russian assets, the Russian partner should have the opportunity to invest in assets owned by the other partner. The value of the assets Rosneft would own in the United States would be in proportion to those Exxon would own in Russia. The agreement is risky, in view of Russia's history of reneging on deals with Western oil companies. For example, in 2006, it compelled Royal Dutch Shell to sell 50% of a Sakhalin offshore property to state-owned Gazprom after Shell had spent more than $20 billion of its own money and that of other investors to build the project's infrastructure.
British Petroleum and Russia's Rosneft Swap Shares
Extending its already close ties with Russia, British Petroleum PLC announced an agreement to exchange shares with Russia's largest oil company, OAO Rosneft, on January 14, 2011. Rosneft is 75% owned by the Russian government. BP and Rosneft also announced the formation of a JV to develop three massive offshore exploration blocks that Rosneft owns in northern Russia. The two firms said they will jointly explore three areas in the South Kara Sea in the Russian Arctic, spending between $1.4 and $2 billion on seismic tests and drilling wells in the initial exploration phase. The JV will be two-thirds owned by Rosneft, with the remainder owned by BP.
Reflecting Europe's escalating dependence on Russia for an increasing share of its energy usage, particularly for clean-burning natural gas, the agreement is backed by Britain's prime minister, David Cameron, and Russia's prime minister, Vladimir Putin. Russia holds one-fifth of the world's proven reserves of natural gas, and, by some estimates, the South Kara Sea contains some of the largest reserves of oil and gas in the world.
The deal comes in the wake of BP's sale of assets to raise funds to cover the costs of the Gulf of Mexico oil spill in mid-2010. Such costs are expected to eventually total $40 billion. Rosneft, which had announced in late 2010 that it was seeking a partner for exploiting its Arctic leases, indicated that BP's experience in dealing with such problems gives it an edge over other potential partners. Rosneft also regards BP's deep-water drilling technology and experience as cutting edge. BP's expertise received another vote of confidence when Australia granted BP licenses to initiate extensive drilling activity off its coast several days after the Rosneft announcement.
The share exchange gives Rosneft a 5% interest in BP's voting shares, making it BP's single largest shareholder. In return, BP receives a 9.5% ownership stake in Rosneft. Each stake is valued at about $7.8 billion. Both firms agreed to hold each other's equity for at least two years before selling any stock. BP's shares currently pay a dividend about twice that of Rosneft's. BP and Rosneft have stated publicly that they believe investors have significantly undervalued their firms. The Russian government has a particularly strong interest in seeing the value of its holdings appreciate, since it announced plans to privatize a number of largely state-owned enterprises, including Rosneft, in 2014 in order to raise funds.
At the time of the announcement, BP's market capitalization was about $154 billion. With almost 90% of its shares owned by the Russian government and Sherbank, Russia's biggest retail savings bank, the firm's stock trading in public markets tends to be limited and not reflective of Rosneft's true value. However, the terms of the share exchange imply a market capitalization for Rosneft of about $81 billion.
The transaction represents the first time there has been a cross-shareholding between major international oil firms and a major government-owned national oil company. Unlike more conventional oil and gas JVs, the Rosneft JV will not own the oil leases but merely the right to develop them. This structure is similar to Russian oil company Gazrpom's agreement with France's Total SA and Norway's Statoil for the development of the Shtokman gas field in early 2008.
Rosneft became Russia's leading extraction and refining company after purchasing assets of former privately owned oil giant Yukos at state-sponsored auctions, in which the global community decried what appeared to be the Russian government expropriation of the privately owned assets. In 2006, Rosneft conducted one of the largest IPOs in history by issuing nearly 15% of its shares on the Russian Trading System and the London Stock Exchange. With the shares priced at $7.55 each, the offering raised about $10.7 billion. Most of the proceeds went to the Russian government. BP began its relationship with Rosneft by buying $1 billion in shares in the firm's initial public offering, equivalent to 1.3%. Thus, the recent agreement brings BP's ownership interest in Rosneft to 10.8%.
Previous attempts to invest in Russia and to create partnerships between Russian state oil companies and Western oil firms have failed due to outright expropriation by the Russian government or heavy-handed tactics employed by certain Russian billionaires (so-called oligarchs) with close ties to the Russian government. For example, Russian officials forced Shell Oil to sell control of its Sakhalin II oil and gas development to state-owned Gazprom. BP and Gazprom signed a global joint venture in 2007 in which each was to contribute assets valued at $1.5 billion, but it was later dissolved due to disagreements between BP and large Russian investors. TNK-BP, BP's 50 percent-owned JV with a group of Russian billionaire business people, has also had a troubled history. The JV that contributes a quarter of BP's global production and nearly a fifth of its reserves was rocked by a shareholder dispute in 2008 that cost BP some of its control. BP chief executive Bob Dudley had served as chief executive of that JV for five years until he was expelled by BP's Russian partners during the disagreement.
On news of the agreement, BP's partners in the TNK-BP JV stated that BP had not notified them adequately and that the Rosneft deal violated their "right of first refusal" as stated in the JV agreement. The partners were successful in getting a court injunction in the United Kingdom to block the implementation of the JV in February 2011. TNK-BP at the time of this writing is considering a legal claim against BP for damages of up to $10 billion for allegedly reneging on its commitment to use TNK-BP as its main vehicle for investment in Russia. These developments raise serious questions about the longer-term viability of the BP-Rosneft JV.
-Speculate as to the purpose of the share swap between BP and Resnoft.

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Definitions:

Relative Deprivation

A subjective feeling of disadvantage that arises from comparing oneself to others and believing oneself to be worse off.

Perception

The method through which living beings decipher and structure sensory information to create a significant perception of their surroundings.

Luxuries

Goods or services that are considered non-essential but desirable and are often associated with high quality and a high price.

Necessities

Essential needs required for basic human survival and well-being, such as food, water, and shelter.