BP’s Risky Gamble with Rosneft

sechin011610.jpgSince the news first broke on late Friday afternoon, observers and oil obsessives have been scrambling all weekend to understand the meaning, precedent, and dimensions of BP’s announcement of its $7.8 billion tie up with the notorious Russian state-controlled oil company Rosneft.

In what has alternatively been heralded as a “pioneering” deal or a desperate gamble (The Daily Mail modestly describes it the “end of the British Empire“), Rosneft will take ownership of a 5% stake in BP, while the British will assume 9.5% of Rosneft.  The newly married companies will form a joint venture to explore three offshore blocks in the Arctic, and, while drilling is still years away, most analysts are viewing the deal as “good news” in the short term for the beleaguered BP.  But coming fresh on the heels of a U.S. government report on the catastrophic incompetence at the Deepwater Horizon oil spill, combined with Rosneft’s notorious opacity and unlawful theft of Yukos assets, others are seeing the deal for what it truly is:  “BP and Russia have embraced each other like two drunks leaning together for support,” Ed Crooks and Catherine Belton write in the Financial Times.

American politicians on both sides of the aisle are none too pleased by the timing of the deal, with calls to review the security implications of BP’s new arrangement, and one congressman commenting that BP now stands for “Bolshoi Petroleum.”

In fact the tie up between BP and Rosneft shouldn’t come as much of a surprise.  The company was previously pressured to put up $1 billion to help out the Russian company’s disputed IPO, in addition to participating in an auction of Yukos assets when almost no other company was willing to do so (no big surprise, BP did not win the auction).  The reason for this was all the trouble going down at TNK-BP and the partial expropriation of the Kovykta gas field.  BP has tremendous exposure in Russia, and the conventional thinking has always been to go along with the corrupt politics and get deeper with state-controlled firms in order to protect assets – although this has repeatedly failed, as Robert Dudley could tell you when he was forced to flee Russia, saw the TNK-BP offices raided, and even several employees jailed.

In many respects, the deal is unremarkable, and far from the “groundbreaking” marriage of an NOC and an IOC.  Like many other authoritarian governments in the world, the Kremlin has control over significant oil and gas reserves.  What they don’t have is capital, technology, and experience to extract it.  Sniffing an opportunity, the IOCs come running for any chance to get a stake in the production, representing the overall perception in the hydrocarbon industry that there is no risk and no consequence too great to prevent them from drilling.  Instead, what’s surprising about the BP-Rosneft marriage is the complete amnesia with regard to past experiences with state corporatism.

On a scale that would measure core competence, appetite for risk, compliant behavior and environmental stewardship, these two companies mirror not only themselves but our times.

It boggles the mind to consider that Rosneft, the brainchild of Deputy Prime Minister and arch-silovik Igor Sechin which derives a majority of its value from the blood assets of Yukos, hooking up with a company currently facing the financial and social consequences of one of the world’s worst environmental disasters.  In terms of a PR narrative, the timing couldn’t be better, as BP talks about its lucrative future developing reserves no one else has access to, while the Kremlin gets desperately needed help to launder stolen assets.

On the surface, BP looks like a winner in the short term, and might experience some positive growth in value.  But the problem is that no one can properly assess the risk of the deal that BP has entered into. The metrics needed to assess the security of its investment in Rosneft simply do not exist, because it is impossible to imagine a scenario in which the two companies have a dispute that is not artificially resolved in favor of Rosneft and its owners in the government of the Russian Federation.

The deal is however a boon for Sechin’s clan, providing them with limited but important access to BP’s empire to continue a program of market disruption at the cost of corporate governance.  Dudley has fashioned a partnership with a company which does not view the oil market as a “market” at all, underscoring the new reality that politics, every bit as much as demand, is the main driver of energy prices.

Perhaps left with few other choices in the wake of its crisis in the U.S., BP has made an existential gamble on this deal, with a potentially transformational pay off.  But the thing is that the house tends to win at the end of the day.