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The Independent (UK)
February 12, 2003
Pioneer deal or Russian roulette? BP's Lord Browne is heading an oil rush into the East - but it's not without risk

FOR A deal that transports BP further and deeper into Russian territory than any other Western company, let alone any other oil major, the secret codename given to yesterday's $13.5bn oil merger was anything but Eastern in flavour.

Project Whitbread conjures images of warm beer drunk on a sunny afternoon whilst watching the cricket on some pleasant English green. But BP's purchase of a 50 per cent stake in Russia's third biggest oil producer for $6.75bn takes it firmly into the icy cold of Siberia and Sakhalin, and to some of the biggest untapped oil and gas resources in the world.

At a stroke, yesterday's three-way deal with Alfa and Access-Renova, the parent companies of Russia's Sidanko and TNK, will increase BP's reserves by at least 60 per cent and its total oil and gas production by 15 per cent. But it is also a gamble, as BP's chief executive, Lord Browne of Madingley, admitted.

It is not a gamble BP needed to take right now, even though its traditional oil fields in the North Sea, Gulf of Mexico and Alaska long since became mature. BP continues to replace production with new reserves at a prodigious rate and it has identified five new profit centres, from Trinidad and Azerbaijan to Angola and the Asia Pacific, which will help lift output by a fifth over the next four years to 4.3 million barrels a day, before its new Russian joint venture has even been factored in.

And as BP's new mantra now has it: production growth is not sacrosanct. Pumping more and more barrels may still be important, but what is even more vital is the profit made on each one of them.

Gamble or not, BP's bold move may be just the catalyst to start a new oil rush into Russia by its fellow Western oil majors - provided they can find the exploration companies to partner up with.

All of the big oil companies of the West, from Exxon-Mobil through to TotalFinaElf are investing in Azerbaijan and Kazakhstan. But it is the corridor from Sakhalin in the Far East through Siberia and on to the Caspian in the south-west where analysts believe the real black gold lies. And it is a region in which BP has now firmly planted its flag following yesterday's deal with TNK and Sidanko, respectively the fifth and eighth biggest oil companies in the burgeoning Russian market.

The deal gives BP a half share in production of at least 1.2 million barrels a day and reserves estimated at anywhere from 5.2 billion to 8.6 billion barrels depending on whether you believe the Brits or the Russians. The Kovytka discovery in eastern Siberia alone is estimated to contain 2 billion barrels of oil and 60 trillion cubic feet of gas.

Analysts estimate the proven reserves of Russia's seven biggest oil companies at more than the oil reserves of BP, Royal Dutch/Shell, Exxon-Mobil, ChevronTexaco and TotalFinaElf put together and reckon that within a decade Russia will overtake Saudi Arabia as the world's biggest oil producer with output of more than 10 million barrels a day.

Not only that, the cost of production in Russia is a fraction of that of the oil majors of the West, making its oilfields hugely cash generative. Once the infrastructure is fully in place to export all the oil Russia is capable of producing, it could wipe the floor with producers in the West.

Steven Dashevsky, head of research at the oil brokerage Aton, says: "What Lord Browne is doing is going to differentiate BP from the rest. On a 10-year view you can't justify not being in Russia. Five years down the line, he is going to be regarded as the pioneer, the person who carried the torch."

There are bound to be some anxious, not to say unnerving moments along the way, however. Many investors got their fingers badly burnt by the Russian debt default of 1998 and the smell still lingers even today. Added to that is Russia's still opaque legal system and the uneasy feeling that large chunks of the country's economy remain in the hands of the Russian mafiosi. The businessmen that BP has now gone into partnership with - Mikhail Fridman, Viktor Vekselberg and Len Blavatnik - may not fit this description.

But the three owners of TNK and Sidanko are the self-same businessmen whom BP accused of attempting to cheat it out of Sidanko's best assets after the British company bought an initial 10 per cent stake in the company in 1997 for $484m. The legal dispute was settled in 2001.

No-one is more aware of this than Lord Browne who first took BP into the Russian market five years ago. "We recognise that many people regard Russia as a risky place to invest but we believe we have learnt a great deal over the last few years, which will mitigate that risk," he said. "The risks are limited and manageable."

BP has done as much as it thinks it can to ensure the governance of the new joint venture company meets Western standards. But, unlike BP's other overseas investments, it will have neither majority ownership, nor management control. BP is also breaking the habit of a lifetime and paying half the price, some $3bn, upfront and in cash.

Previous transforming deals - such as the $48bn takeover of Amoco in 1998 and the $20bn acquisition of Atlantic Richfield two years later - were paid for with shares whilst last year's acquisition of Veba of Germany, which turned BP into the biggest petrol retailer in Europe's biggest market, was financed largely through an asset swap, reducing the net cost to BP to less than $1bn.

BP argues it is paying no more than the Russian market average for its half stake in the new joint venture. It says the deal will increase its earnings per share from day one whilst over a four-year period the joint venture could deliver some $7.5bn of benefits in the shape of cost improvements and production growth. BP's new Russian partners and some independent oil analysts calculate that BP is paying a premium of anywhere between 50 and 90 per cent, depending on what valuation measure is used.

Whether the price was high or not, the deal certainly had a galvanising effect on the London market yesterday, sending BP's shares 4 cent higher and helping lift the FTSE 100 index by 2.5 per cent. One of BP's shareholders, Ivor Pether of Royal London Asset Management, said he was "pretty agnostic" about the deal as he went in to listen to Lord Browne's three-hour presentation. "Taking a 10-year view is the right way to go and provided BP can reassure us about the corporate governance issues, then entering Russia with its low-cost oil production base could be quite a good move. The piece of the jigsaw that is missing is the disposals that BP will presumably make to pay for this transaction."

What is certain is that having taken the plunge, BP is now committed to making a success out of what Lord Browne described as the company's sixth new profit centre. As he said yesterday: "This transaction makes Russia a very important element in the long-term renewal of BP." Amen to that.

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