BP "Russia's" in where Shell fears to tread

This post was written in 2012–2013 and reflects thinking at the time. For current views and topical discussions, please see recent articles.

BP has swapped its 50% stake in TNK-BP for c.20% of Russia's NOC Rosneft. The Rosneft stake may well be under-valued by the markets and represents an excellent investment for BP. This is a result of Bob Dudley playing by the rules and not trying to pull the fast one on the Russians, which was the undoing of Shell a few years ago.

Firstly, apologies for the bad pun in the title...

I have written not long ago about BP's long courtship with Rosneft. Now we are about to see a marriage of sorts, with an equity swap of BP's 50% holding in TNK-BP for 18.5% of Rosneft's stock (plus cash). In parallel, Rosneft will be buying out the consortium of Russian "oligarchs" who own TNK-BP's other 50%.

Much has been written about this in mass media since the deal was announced on Monday, so I wasn't going to add my own two pence' worth of wisdom. However, media commentary has included one motive that to me appears to be plain wrong. It is said that BP acquired Rosneft's shares at a 12% premium to the share price, while usually shares-and-cash deals attract a discount on the share element. What this ignores, though, is that Rosneft, while being a quoted company, is an NOC so cannot be measured by the same criteria.

Rosneft's P/E ratio is estimated around 7.2 for 2012; BP itself, despite the negative investor sentiment ever since the Macondo disaster, is estimated  to close 2012 with 7.8. Shell has a 2012 estimate of 8.1, Statoil of 8.3, Chevron 8.6, and ConocoPhilips 10.1. (By contrast, another Russian oil major Lukoil is expected to close the year on 4.5 for ADR.)

What this illustrates is that most of big Russian companies have been traditionally under-valued in the markets. There have been good reasons for that, such as historically volatile political, regulatory and fiscal environments. However, the last 12 years have been an era of stability on all those fronts. I would argue that BP's 20% investment in Rosneft (it already had a 1.5% stake) is its least risky asset. Compare it with a field in offshore West Africa or any asset at all in the US. Which would make you lose more sleep?

This deal is a vindication of Bob Dudley's long-term strategy. For years he has doggedly pursued collaboration with sovereign oil interests in Russia, even when he, as then the CEO of TNK-BP, was being thrown out of the country at the instigation of his oligarch "partners". That doggedness has now paid off and the company has completed the re-focusing of its long-term strategy. Compare this with the shambles that Shell got itself into a few years ago over its own Russian investment, Sakhalin 2.

Having pushed through an outrageously one-sided production-sharing agreement with the Russian government in the mid-1990s, Shell thought that it didn't have to play by the rules. Costs were being inflated to show low profitability; localisation requirements on procurement were being ignored; environmental impact was being disregarded. When a few years later Russia acquired a functioning government, all this quickly came to an end and Shell, threatened with having its licence revoked, was forced to sell its interests to Gazprom.

By contrast, Bob Dudley understands the rules of the game and recognises that in order to take, an investor also needs to give. I feel this will be a good deal all around, which opens new opportunities for BP in the Arctic, Russian Far East and the Caspian, as well as joint projects with Rosneft in other parts of the world. Well done, Bob.

Will Gazprom dare bid for Centrica this time?

This post was written in 2012–2013 and reflects thinking at the time. For current views and topical discussions, please see recent articles.

Rumours of a Gazprom bid for Centrica have surfaced again. Last time around, the strength of political opposition to a deal prevented a formal bid being made. Will the commercial logic prevail this time around, with BP collaborating ever more closely with its Russian partners?

As every fool knows, vertically integrated energy companies tend to have an easier time coping with the vagaries of market conditions. For that reason Centrica, having inherited the supply business of British Gas, has felt somewhat naked without upstream assets to underpin it. The company has bought or built several power plants and entered the North Sea E&P arena. That, however, has taken it only part of the way from dangerous dependence on wholesale energy markets. Among other sources, the company buys piped gas from Norway's Statoil and LNG from Qatar (mostly the state-owned Qatargas), under long-term gas supply contracts. Just a few days ago Centrica signed yet another one of those, this time with Russia's Gazprom. This is Centrica's way of limiting its exposure to the UK's notoriously volatile spot market.

Incidentally, Gazprom has the opposite problem. While it is a quasi-monopoly in Russia, the company lacks a sufficient downstream hedge, which it felt very sharply in 2008 when the international oil and gas prices nose-dived. So far, apart from some asset swaps giving it exposure to the distribution and supply business in Germany, the company has failed to gain a foothold in Western Europe's retail markets, which it would love to do.

It is therefore not surprising that Cordi O'Hara, one of Centrica's directors, sees in the Gazprom tie-in "a natural fit with one of the world's largest gas producers and exporters". Why then not take it a step further? What about a formal JV or a full-on merger? Indeed, rumours to that effect have been circulating for a couple of weeks now. With the Nord Steam pipeline from Russia into Germany seemingly on track, and a spur pipeline expected into the UK, this would make even more sense.

The commercial logic is obvious. In the energy business, however, politics often trumps economics. It was almost exactly seven years ago that BBC Business News called me for a comment on the "imminent" Gazprom bid for Centrica. My response then was "this isn't going to happen". There are too many vested interest opposed to a closer business relationship between the UK and Russia. Nothing since then has made me change my mind. We've had the "Litvinenko affair" in London, the "spy stone" in a Moscow park, vehement disagreements over Libya and Syria, and so on. However, I am now becoming to feel cautiously optimistic that the political opposition may be weakening. There are two words that explain this: Deepwater Horizon.

Why should BP's misfortune in the Gulf of Mexico have any bearing on this? In a nutshell, BP's struggle for survival since the blow-out has shown in stark relief the importance for key UK businesses of cooperating with Russia on energy issues. Bob Dudley, BP's CEO who took over in the aftermath of the disaster, has built the entire recovery strategy around opportunities in Russia as well as JVs with Russian partners. Last year BP's 50% holding in TNK-BP provided 90% of BP group's dividend. Even bigger potential prizes are at stake in the Russian sector of the Arctic. BP's Eastern strategy deserves a separate blog post (watch this space!), but the main point is clear. If "British Petroleum" (as president Obama kept calling the company) is allowed to take piece of the action in the Russian upstream, why should Gazprom not be allowed to take a piece of the action in the UK retail market?

One shouldn't expect a plain sailing, obviously. The European Commission's recently launched anti-monopoly investigation into Gazprom will not help matters in the short term. However, the EC is clearly concerned with the bigger picture - the commercial basis on which the EU cooperates with out-of-region energy suppliers. The investigation may also serve to soften Gazprom into accepting a more limited deal than a full take-over.