I made a short guest appearance on France 24 television last night, to talk about the Exxon joint venture deal with Rosneft to explore the Russian Arctic for oil and gas. Here’s the clip, along with some notes on the deal and my perspective.
Exxon Scoops BP for Arctic Exploration Deal
The Race for Arctic Oil Is On
By Chris Nelder
Wednesday, August 31, 2011
Yesterday Rosneft, the 75% state-owned Russian oil giant, kicked BP to the curb in favor of ExxonMobil as its joint venture partner to explore Russia’s portion of the Arctic for oil and gas.
Where BP Went Wrong
Rosneft needed a Western oil company partner with the deepwater drilling expertise to tap one of the most challenging and untried oil provinces on earth, the Arctic.
BP thought it had secured the partnership back in January, and had touted it as part of its future growth strategy to recover from the Macondo well disaster in the Gulf of Mexico. That strategy is now thrown into question.
BP had offered Rosneft a 5% stake in BP in exchange for a 9.4% share of Rosneft, in a $16 billion share swap deal. BP’s investors hated it, partly because it would dilute their shares, and partly due to a longstanding aversion to having Russian owners in the company. But that’s not what killed the deal.
BP had some Russian billionaire partners known as AAR—Alfa, Access and Renova—in a separate joint venture called TNK-BP, which BP was supposed to represent as its exclusive partner for investments in Russia. AAR viewed the overture to Rosneft as a breach of that agreement, and they opposed the deal, which was later voided in arbitration. BP attempted to buy them out for $32 billion in May, but failed. That left the door open for Exxon.
Exxon offered a simpler exchange of assets, which would not dilute its shareholders. Exxon will gain access to three oil deposits Russia’s East Prinovozemelsky blocks in the Kara Sea, and one in the Tuapse license block in the Black Sea. In exchange, it will give Rosneft a joint venture role in at least six of its exploration projects in the Gulf of Mexico and “tight oil” formations inTexas. Rosneft liked Exxon not only for its expertise and deep pockets; they also salivated over the prospect of getting more exposure to oil and shale gas fields in the US. Further, Exxon was already a trusted Rosneft partner, working with it on an offshore project near Russia’s Sakhalin island.
Exxon will put up $3.2 billion in initial funding for the joint venture. Drilling is expected to commence in 2015. Rosneft will have a two-thirds stake, and Exxon one-third, but Exxon will bear the lion’s share of the exploration costs.
Some $200 billion to $300 billion dollars in direct expenditures are anticipated to develop the Russian resources, but the total project cost might be as high as $500 billion including related infrastructure investments, according to Vladimir Putin.
In short, Exxon got a better deal with fewer concessions than BP had offered, and BP’s CEO Bob Dudley came off looking like an inferior negotiator to Exxon’s Rex Tillerson. More to the point, BP showed that it couldn’t play Russian oil hardball. They weren’t prepared for it legally, nor did they have the political savvy to survive internal Russian business politics. During earlier negotiations in July 2008, as readers may recall, Dudley fled Moscow and went to a secret, high-security location in a hurry, to escape intimidation by Russian authorities (likely at the behest of AAR) who intended to summon him for questioning over alleged violations of labor laws. I don’t blame him for wanting to escape the same fate as Mikhail Khodorkovsky, but I do think he was a bit out of his league in negotiating with the Russians. Tillerson, in contrast, is a tried-and-true American oil company warrior.
As further evidence that BP might be having “a spot of trouble” with the Russian oligarchs, their offices in Moscow were raided today by Russian court officials, in pursuit of a lawsuit filed by AAR. Non-executive employees were sent home and the offices were sealed, Reuters reported. But political analyst Nikolai Petrov of the Moscow Carnegie Center downplayed the raid, calling it “a coincidence in timings,” not evidence that BP will see further pressure from Russian authorities.
BP is now working to convey the image that it still has other meaningful opportunities, including Brazil, the Caspian Sea, Australia and elsewhere. However BP is still unable to resume drilling in the Gulf of Mexico after the Macondo well disaster. BP has lost 22% of its market capitalization this year.
How Big Is The Prize?
The Arctic is thought to hold one-fifth of the world’s undiscovered, recoverable oil and natural gas, according to the most recent (2009) assessment by the United States Geological Survey (USGS). Sixty percent of the oil is concentrated in just six small areas (“assessment units,” or AUs, in USGS parlance), predominately in Alaska, and two-thirds of the undiscovered gas is in just four AUs, predominately in Russia. Of the 61 significant Arctic oil and gas fields, 43 are thought to be in Russia. The Russian Arctic is thought to be gas-prone, while the North American Arctic is likely richer in oil.
Rosneft claims there are an estimated 36 billion barrels of recoverable oil in the Kara Sea, out of a 110 billion barrel resource base. The Black Sea block is thought to have 9 billion barrels of reserves. However those numbers are probably on the high side.
As I detailed in my June 2009 article, “Arctic Oil and Gas Potential,” USGS gave a 95% probability for there being 44 billion barrels of oil, and 770 trillion cubic feet of gas, waiting to be discovered in the Arctic. Allow me to underline that these are undiscovered resources. At 50% probability, they said there might be 83 billion barrels and 1547 trillion cubic feet of gas. In my experience, the P95 numbers should be used, especially in an area we know so little about. So I am skeptical of the claim offered with the news of this deal that there are 60 billion barrels recoverable in the Arctic. Assuming a generous 25-35% recovery factor, the Arctic may in fact have only a 4-month world supply of recoverable oil, and around a 2-year supply of gas.
Even so, I think it’s safe to say that Exxon got a pretty good deal in the Rosneft joint venture, even assuming the high estimate of $500 billion for the total project cost. If the 110 billion barrel number is credible for the Kara Sea resource, and they are only able to achieve the low end 25% recovery factor, they’ll get around 27 billion barrels out of it for a production cost of $18.18 per barrel. And if the high 60 billion barrel recoverable figure is correct, the cost would be a mere $8.33 a barrel. With Brent crude trading at $115 today, the payoff for the joint venture could be huge either way.
But we must never forget that oil exploration in the briny depths is always a highly risky endeavor. It’s not unusual in today’s oil business, while trying to plumb the most remote resources on the planet, to drill a $200 million dry hole. It’s not unusual to run into unforeseen technical challenges, or have equipment failures, as we all saw last year. It’s very likely indeed that the $500 billion figure will turn out to be on the low side, as the original project timeline gets stretched out, and prices for key structural commodities like steel rise to heretofore unseen levels…especially if my guess is right, and the world enters the age of terminal oil decline starting around next year. And if that happens, prices could spike like they did in 2008, crushing demand, and forcing oil prices back down to very low levels. So the Arctic prize may or may not turn out to be as golden as this quick math might suggest.
Indeed, altogether new technology will have to be developed to produce oil from the Arctic. Exxon and Rosneft will create an Arctic research and design center in St. Petersburg to invent it, as part of the joint venture. For example, the oil business currently does not know how to clean up a spill in the months-long night of Arctic winter. Technology to manage ice will be needed, and higher specification components will have to be developed that can endure the freezing conditions. Even simply housing and feeding the workers and attending to their medical needs so far from civilization will be a major challenge. All of this will extend the usual timelines for deepwater projects significantly.
Until next time,
Arctic Oil and Gas Potential
Energy analyst Chris Nelder summarizes a new USGS report on the oil and gas potential of theArctic.
Arctic Oil and Gas Challenges
Energy analyst Chris Nelder reviews some of the challenges that face Arctic oil and gas de