Energy prize in Russia's far north fuels speculation of BP-Rosneft deal

For two weeks, international oil circles have been abuzz about a fiendishly clever plot -- a plan by BP PLC to divorce from its disputatious Russian partners and to win the favor of a new spouse with eye-popping real estate: the Russian state oil company, Rosneft, and its coveted property, the hydrocarbon-rich Russian Arctic.

If true, BP would be seeking a prized spot along with Exxon Mobil Corp., Italy's Eni and Norway's Statoil in one of the richest untapped oil and gas regions on the planet. According to the U.S. Geological Survey, Russia's Arctic contains more than 200 billion barrels of undiscovered oil-equivalent hydrocarbons, most of it natural gas.

BP declines to discuss the subject. But such a plan would require highly agile political footwork and, even if successful, could lead to a thornier challenge: How to survive in a global landscape being redefined by the U.S. shale gas revolution, a flood of ultra-cheap fuel that is eroding the economics of rival fields, especially in high-cost regions such as the Arctic.

Already, the U.S. shale bonanza has stranded a large volume of gas in Canada's northern Mackenzie Delta by denying it the most obvious market, the lower 48 U.S. states. The shale threatens to do the same to an even larger quantity of gas -- the equivalent of 6 billion barrels of oil -- bottled up on Alaska's North Slope. Now, analysts say the U.S. gas may fatally undercut fields up for grabs on Russia's far-north Barents and Kara seas. "[The development of] Barents Sea gas is right at the top of the cost curve," said Neil Beveridge, an analyst with Bernstein Research.

The global energy industry is undergoing an apparently transformational shift in which extraordinarily large new volumes of both oil and gas have been discovered in the United States, Africa and South America. Enthusiasm is especially high regarding the U.S. shale patch, which has helped to create a global glut of gas. But the world's major global companies appear to be similarly eager about the Arctic, whose daunting conditions make it penetrable only by the biggest and most able oil companies.


The main trigger for the Arctic excitement is global warming -- an approximately 1.5-degree-Celsius rise in average temperatures above the Arctic Circle in the last 60 years, which has caused summer Arctic ice to recede and made drilling more possible.

But politics also plays a role: Russian President Vladimir Putin, confronting an economic squeeze because of insufficient government revenue and a lagging economy, is aggressively pushing to raise Russia's medium- and long-term oil and gas export revenue.

In the weeks before officially moving back into the Kremlin last month, Putin, as prime minister, finalized three blockbuster Arctic deals. In April, he observed as Exxon Mobil Corp. CEO Rex Tillerson signed what was described as a strategic alliance with Rosneft to drill in the Kara Sea, in addition to other projects. Later the same month, Putin watched as Eni signed a deal with Rosneft to jointly develop fields in the Barents Sea. Last month, he presided over a Statoil deal to develop a Barents Sea field.

BP's Russia strategy in flux

The deals involved billions of barrels of projected oil reserves and the equivalent in natural gas, by and large the latter. But high average oil and gas prices would be necessary over decades to justify the daunting costs of Arctic development. Rosneft CEO Igor Sechin, for example, has estimated that the cost of developing the three Arctic fields in the Exxon deal could be $200 billion to $300 billion, 10 times the $20 billion to $30 billion that Big Oil ordinarily regards as considerable project investment.

But the deals come against the backdrop of an apparent long-term gas glut led by cheap U.S. shale gas. While gas prices in Europe were about $11 per thousand cubic feet in Europe last month and Asian prices have been around $17 per thousand cubic feet, U.S. gas has stayed low, with futures contracts closing at $2.55 per thousand cubic feet Friday.

BP's interest in Russia's far north goes back to last year, when it was technically first in the new wave of Arctic deals. In January 2011, it signed a deal for three Arctic fields. That deal, however, was overturned in a scuffle with its Russian partners in another venture called TNK-BP. A few months later, Exxon snapped up rights to the very same fields, in the deal made official in the Moscow ceremony two months ago.

Meanwhile, a corporate war was on between BP and its TNK-BP partners, four Russian oligarchs whose partnership is known as AAR. The scuffling climaxed June 1 with a BP announcement that it is entertaining offers to sell its stake in the venture. Numerous industry analysts have said that, if BP can extricate itself smoothly from the partnership, its ultimate goal will be a fresh deal on the Arctic.

Toby Odone, a BP spokesman, declined to discuss the outside assessment of BP's strategy. "Speculation is rife about this whole sale process and what happens after," he said in an email exchange. "I am very sorry but we are not going to fuel that speculation."

Given how BP's prior attempt to buy Arctic assets blew up in its face, and its ongoing brittle dealings with AAR, the British company is likely to be ultra-cautious navigating the next few months of negotiations in Russia. Rosneft has denied that it is in talks to buy BP's share of TNK-BP and has not commented on any new Arctic potential for BP. In a statement, Gazprom, the Russian gas company, said that it "holds regular consultations with the partners covering a broad number of issues; however, right now it is still too early to talk of any negotiations with BP regarding the Arctic stake development."

Yet, even if BP navigates AAR and Rosneft, and ends up back on the Arctic, it will be in the same position as the other big oil companies -- confronting the disruptive impact of the U.S. shale.

Chris Weafer, chief strategist for Troika Dialog, said that Putin himself will attempt to outwit the shale gas revolution by offering lower tax rates and other better contract conditions. He said that for Putin, the rationale is not only economic, but political.

"Putin has always equated a dominant position in global energy with geo-political power and global relevance," Weafer said in an email exchange. "To that extent, the decision to develop projects and energy infrastructure is not only financial but political. Hence projects that don't fit normal investment criteria can still be built -- and justified with more favorable long-term price assumptions -- because they also satisfy the broader geo-political criteria."

Charles Ebinger of the Brookings Institution said that another wild card is Japan, which has been aggressively seeking natural gas since shutting down its nuclear power reactors in the wake of the 2011 Fukushima Daiichi nuclear plant disaster. "I think it is very possible [Russia's Arctic projects] do not proceed," Ebinger said. "But keep in mind that Japan has historically been willing to pay a premium for security of supply."

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