Posted on 13-2-2003

BP Plays Oil Card In Russia
By Sabrina Tavernise with Neela Banerjee, NYT Feb 12 2003

BP, the world's third-largest oil company, agreed today to pay $6.75
billion to form a new Russian oil company. The deal underscores the growing
attractiveness of Russia to foreign oil concerns and could increase the
country's already significant role as an exporter of crude oil.

Under the deal, which is the largest single investment in post-Soviet
Russia, BP will merge its assets in the Russian oil company Sidanco with
those of several Russian businessmen who own two other Russian oil
producers. The resulting company would become Russia's third-largest oil
producer. BP will pay cash and equity for a 50 percent stake in the new
company.

Analysts and companies warn that because Russia is still a difficult and
uncertain place to do business, it is unlikely that other foreign oil
powers will race in after BP. Few foreign oil companies appear willing to
invest a great deal in Russia unless the government creates a better tax
regime and a stronger legal system, oil executives and analysts said. "All
the major oil companies have been active in one way or another in Russia,"
said Walter van de Vijver, group managing director and head of exploration
and production for Royal Dutch/Shell , which has invested more than $2
billion so far in the Sakhalin 2 offshore project in the Russian Far East.
"All of us have had difficulty getting our projects off the ground. It's
very easy to invest money, but how easy is it to get your money out? The
risks in Russia remain."

But Russia may have become too important to ignore. For the last year, the
Bush administration has praised Russia as a stable source of crude oil to
world markets, while political instability has plagued other regions that
export a lot of oil, most notably the Middle East and Venezuela. Russia's
oil output grew nearly 9 percent last year, and by the end of the year, the
country had overtaken Saudi Arabia as the world's largest producer, though
Saudi Arabia still exports more oil. "There's been a lot of talk about
diversifying away from dependence on Middle East supplies," said Stephen
O'Sullivan, head of research at the United Financial Group , an investment
bank in Moscow. "It's all very well for governments to say. BP is creating
a new production province for itself in Russia."

The BP transaction comes as the largest international oil companies have
had to acknowledge the difficulties they face trying to increase oil
production through their own exploration and production. One way to meet
ambitious growth forecasts, analysts say, is for some companies to acquire
others, the path BP appears to have chosen. "The acquisition may reflect
the growing difficulties faced by the majors in replacing their reserves,"
said Mehdi Varzi, president of Varzi Energy, a London consulting firm.
"Russia will remain a relatively hard place to enter, but the BP deal is
definitely encouraging."

Indeed, the transaction is a major vote of confidence in President Vladimir
V. Putin's economic reforms. Foreign investment has begun to trickle into
the oil industry since Mr. Putin's presidency began, but BP's $6.75 billion
investment is huge, equal to a quarter of all foreign direct investment
since 1992. Mr. Putin, in France on an official visit, told French business
executives today that the deal showed Russia's economic climate had improved.

Mikhail Khodorkovsky, chief executive of Yukos, who was attending an
industry conference in Houston today, said, "This is an important symbolic
moment: that one of the big majors who has been working in Russia for a
long time decided to make a major investment under the normal national tax
regime."

BP already owns several Russian assets, including 25 percent of Sidanco.
The company said that by deepening its commitment to Russia, it could lift
production at a time when its workhorse fields were declining. BP missed
its production growth target this year and announced today that it would no
longer provide the market with production forecasts.

BP's 50 percent stake in the new Russian company would bolster its energy
production 13 percent and lift its oil reserves 30 percent. It would put
BP's output on par with Royal Dutch/Shell, the world's second-largest oil
producer, after Exxon Mobil. BP would be paying $2.60 for each barrel of
reserves, a price some analysts called high. In a statement today, BP's
chief executive, Lord Browne, cited Russia's "greatly improved economic
stability, improved legal system and increasing commitment to the
international rules of trade and business," as reasons for BP's decision to
make the purchase.

The company's experience in Russia in many ways mirrors the country's own
roller coaster of economic development. The company bought 10 percent of
Sidanco in 1997, but quickly hit trouble when the company's Russian
managers ran up large debts. Two years later, another Russian concern,
Tyumen Oil, snatched a crucial oil-producing subsidiary from Sidanco in a
bankruptcy procedure that BP said was rigged. BP later reconciled with
Tyumen. The owners of Tyumen Oil — the Russian conglomerate Alfa Group and
the Russian-American Access Industries /Renova Group — are BP's partners in
the new venture. The risks are different now. Instead of share dilutions or
asset losses, BP executives will face the extremely difficult task of
reorganizing a Russian company. At the heart of that task will be
establishing real control over the company itself down through its middle
management. Also, a small stake in the assets held by Sibneft, another
Russian oil concern, will have to be addressed.

Robert Dudley, a BP group vice president, said at a news briefing today
that BP would appoint the chief executive and a team of about 20 top
managers for the new company. The agreement also provides for international
arbitration in Sweden in case of serious disagreements. The Russian
partners "have said their expectation is that we will bring management
talent to run operations," Mr. Dudley said. "It's clear what they want is
an efficient, world-class company."

Foreign oil companies have long lobbied the Russian government to adopt a
set of laws and regulations called a production sharing agreement that they
say they believe would protect their investments better than what is now on
the books. So far, progress on the new rules has moved at a glacial pace,
largely because of resistance by crucial politicians as well as by many
Russian oil companies themselves, which do not want foreigners on their
turf. Today's deal appears to be an admission, at least by one company,
that it if plans to work in Russia, it will probably have to do so on the
Russian companies' terms — at least for now.

BP began talking seriously with the Russian groups in September, and on
Feb. 4 a breakthrough in negotiations led to the final deal, Mr. Dudley
said. The new company is expected to produce 1.2 million barrels of oil a
day and would include other assets, including licenses for oil exploration
off Russia's Pacific Coast island of Sakhalin and networks of service
stations, he said.

The news of the purchase sent Russian stock and bond markets soaring. But
investors will be watching the new partnership closely as a benchmark of
Western success in the Russian oil industry. "The pace of change has been
very fast" in Russia, Mr. Dudley said. "That has given us the confidence to
make this investment. We did not take it lightly."