COMMENT: Knowns and unknowns in the TNK-BP dispute end-game

By bne IntelliNews April 11, 2011

Chris Weafer of Uralsib -

The arbitration court ruled on Friday, April 8 to keep in place the injunction blocking BP's deal with Rosneft. Russia's Deputy Prime Minister in charge of energy policy, Igor Sechin, responded by giving both parties - BP and a group of Russian businessmen in the AAR consortium - a deadline of April 14 to resolve the issue or risk sanctions. Sechin is also chairman of Rosneft and is one of the officials under pressure to either leave government or leave the board of Rosneft.

It is believed that the government had adopted a back-seat approach to the dispute between BP and AAR, the two shareholders in the TNK-BP joint venture, while the two parties tried to resolve the issue between them. Now that this has failed, we can expect that there will be a lot more pressure applied this week and, if no agreement is reached by Thursday, then direct intervention by the state.

Apart from this deadline, BP will also now be in a hurry to resolve the issue, as it is affecting the company's share price. Weekend media already mentioned the prospect of BP becoming a takeover target if the valuation stays as low as it is now.

So, what happens now? We are into (former US Defence Secretary) Rumsfield territory, ie. the known knowns, known unknowns and unknown unknowns. It's as good a way as any to look at the situation.

The known knowns

We know that this deal is too important for Russia's long-term strategic interests to be allowed to fail. Russia wants to remain the world's biggest energy producer. That is the country's principal competitive advantage in geo-politics and as it looks to increase trade and investment access. Russia wants to keep oil production as close to 10.0m barrels per day (10.2m b/d average in March) as possible and, given the likely decline in West Siberia over the next 10 years, it can only ensure this by opening up new exploration territory such as the Arctic.

Russia also wants to be at the forefront of Arctic exploration, as it sees this region as being mainly in its backyard. Realistically, the Russian producers do not have the technology or experiences to go it alone in new environments such as the Arctic and, therefore, need the partnership of international majors such as BP.

Russia also wants to conclude the deal with BP because, along with Shell, the company's previous deals in Russia are regularly cited by critics as an example of bad investment experience and justification for the high-risk premium. For BP to make such a large new commitment to Russia allows the government to show that the rules of the game have improved.

We also know that BP wants, if not needs, this deal. Life will be increasingly difficult for BP in the US, and Russia is one of the very few locations where the company can go to access new production growth. Otherwise it risks a permanent downgrade of its valuation and a more serious threat of takeover hanging over it.

Finally, a clear "known" is that the AAR shareholders, a group of Russian businessmen, do not want to left on the sidelines with an investment that is going nowhere. If the original deal were to proceed as announced, then TNK-BP would be parked into a cul-de-sac in the Russian oil industry. Good production and cash flows, but zero growth potential. AAR wants to be either brought into the deal, ie. where it can access future growth, or to have an exit route opened for them. AAR's position has been greatly strengthened by the Arbitration Court ruling.

The known unknowns

By far the most likely outcome is that a deal will be worked out. The alternative is that the state/Rosneft dump the deal and try to work with another international oil major. There are many obvious reasons why that simply would not work. What we are almost certainly looking at is a BP-Rosneft deal with a TNK-BP accommodation, either in or outside the formal deal.

There are several possible scenarios;

--BP may agree to drop out of the original deal with Rosneft and allow TNK-BP to take its place. That is unlikely, as the reason why the government wants an international oil major, such as BP, is so that they can use their technology and expertise. TNK-BP does not have deep-water experience and would have to "contract" BP to actually do the work.

--The original deal could be re-worked so that TNK-BP, as an independent entity, may be admitted as a third partner to the JV. That's possible but that it would be an obvious political rather than business solution. Hard to see what TNK-BP would bring to the deal.

--The third possibility is that Thursday's deadline passes and we then start looking at an exit route for the AAR shareholders from TNK-BP. AAR has clearly stated that it is not looking for an exit, but it is an obvious possibility if they cannot get into the BP-Rosneft deal. The main shareholders in TNK have significant, and growing, business interests elsewhere and the oil industry is now dominated by the state. There are several sub-scenarios as to how an exit route may be opened for AAR, including either an outright sale or a share swap that would allow for a longer-term exit strategy. Most likely with a Russian state buyer/partner rather than with BP.

The unknown unknowns

What we don't know is why the issue ended up in arbitration and why it is on the brink of either failing (unlikely) or a major revision. BP will have done its due diligence and understood the risk. But, for reasons we are not aware of, BP management assumed that AAR would not take the action it has or would have been persuaded against it. There are many conspiracy theories as to what happened and what alternative game may be now playing out in the background. How those "other" issues affect the final outcome is pure guesswork at this stage.

Chris Weafer is chief strategist of Uralsib

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