At the beginning of this month, oil giant BP announced that it intended to pursue the sale of its half share in the TNK-BP joint venture in Russia - a perennial source of discord in recent years. BP's chief executive, Bob Dudley, said the UK energy giant had received "unsolicited approaches" for the stake.
The statement of intent took the market by surprise - and attracted immediate opposition from the other shareholder, Alfa Access Renova (AAR), a consortium of companies controlled by various Russian billionaires, of whom Mikhail Fridman is the most prominent. AAR has threatened to veto any deal, and also dropped hints about increasing its own shareholding, although it has since emerged that AAR had approached France's Total with a view to hiving off its own stake. Although the terms of the AAR pitch have not been disclosed, it was deemed "too expensive" by Total's chief executive, Christophe de Margerie.
BP has been busy selling off "non-core" and "mature" assets in the wake of the 2010 Gulf of Mexico oil spill, but its stake in TNK-BP does not fall into either category. It's financially and operationally important (see below). So it seems likely that the breakdown of the relationship between the shareholders (see 'The background' below) is the main motivating factor.
Financial impact
Selling the TNK-BP stake could provide a handsome windfall - if BP can get a fair price for it. Analysts think it could be worth around $30bn (£19.3bn), but those at Societe Generale commented that: "BP's potential exit from Russia heightens strategic uncertainty - it is uncertain whether BP can extract fair value or what it would do with the sale proceeds."
Peter Hutton, an analyst at RBC Capital Markets, points out that the sale has the potential to eliminate net debt and shore up BP's post-Macondo fighting fund, in addition to providing sufficient liquidity for a large-scale acquisition. It is, he says, "strategically and tactically welcome, and accretive for value."
But financially and operationally, TNK-BP would be missed. The joint venture is run independently, with the two shareholders receiving dividends. The chart below shows how vital those are, especially in the post-Macondo era. In 2011, BP paid out $4.1bn in dividends to shareholders - of which $3.75bn came from TNK-BP. Since formation, TNK-BP has paid out over $19bn to BP in dividends - a great return on the initial $8bn or so capital investment.
The venture accounts for almost a third of BP's output and a quarter of its reserves, and it's a big factor in the group's positive reserve-replacement ratios (how much production is replaced with new reserves each year). So, how would BP replace such a prodigious source of cash - and what would be the impact on shareholders?
Outcome 1: "Get a new wife"
Bob Dudley, BP's chief executive, has explicitly stated that BP has no intention of moving out of the Russian oil and gas sector per se. So if it is withdrawing from TNK-BP, it is doing so in order to freely pursue other opportunities within Russia. As Mr Fridman has said in the past: "If you want to marry a new wife, you have to divorce the old one first."
And what better way to curry favour with the Kremlin than by delivering half of the TNK partnership into the arms of a state-controlled oil company? That would substantially increase the state's share of Russia's oil output, while further entrenching Vladimir Putin's power base following his return to the president's office. It would also leave BP free to pursue initiatives such as the tie-up with Rosneft it was forced to abandon in 2011. The Kremlin likes to be in control, but it needs technology too - look at Rosneft's recent shale oil tie-up with ExxonMobil in Siberia. Mr Putin and Igor Sechin, the head of Rosneft, would presumably still want to bring BP's deep-water drilling experience to bear in the Arctic.
| The background |
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Few western companies have found operating in Russia straightforward, and BP is no exception. The formation of TNK-BP in 2003 via a pooling of assets and a cash contribution from BP was supposed to draw a line under BP’s previous Russian misadventures, while giving the AAR consortium some protection from the Kremlin and access to western technology. With Bob Dudley as chief executive, TNK-BP increased its output by a third and became one of the 10 largest private oil companies in the world. But tensions soon emerged, and culminated in Mr Dudley being denied a visa to work in Russia and running the venture from exile. He eventually resigned as chief executive in 2008 (only to become boss of the whole of BP in 2010). AAR particularly objected to BP’s attempts to cultivate alliances with other Russian entities, particularly Gazprom and Rosneft – a proposed tie-up with the latter saw BP and AAR face each other in court during 2011. In late May, Mr Fridman resigned as chief executive of TNK-BP and the venture’s board is now effectively inquorate. In addition, AAR is suing BP for $13bn over 2011’s dispute. |
Outcome 2: The tables turned
The problem for the oligarchs - Mr Fridman, German Khan, Viktor Vekselberg and Len Blavatnik - is that any deal between BP and a state-owned group might marginalise the four billionaires and effectively leave them at the whim of diktats from the Kremlin.
Maybe that's the idea, and that Mr Dudley - the devil they know - is calling their bluff by threatening to sell out. There is speculation that AAR would struggle to raise the finance needed to buy out BP at a meaningful price, and whether it actually has first refusal on the BP stake. Unconfirmed reports have already emerged that Mr Vekselberg is considering selling his stake unilaterally, which could seriously undermine the subsequent influence of the consortium. If AAR were to sell out, allowing BP to bring in an alternative Kremlin-blessed partner, that would be a massive coup for Mr Dudley - but it's a very big 'if' and BP might have to pay a high price for securing Moscow's blessing.
Outcome 3: Macondo blows again
Even if BP extricates itself from TNK at a fair price, there is another big unknown - the scale of BP's final bill from the Gulf of Mexico spill in 2010. This is dependent on whether the group is found guilty of gross negligence in the matter. Although this scenario is perhaps unlikely, it would substantially increase the statutory pay-out and could conceivably provide a catalyst for the break-up of the group.
It has been reported that BP is trying to reach an agreement with the US Department of Justice whereby the group would part with $15bn to cover all civil and criminal damages, in addition to the previous $7.8bn settlement that compensated third-party claimants affected by the spill. A settlement would be advantageous to both parties as it would avoid years of costly and potentially ineffectual litigation, but investors are unlikely to get any clarification on this matter until the autumn.
Outcome 4: Different place, different people
BP cuts a deal with the Russians and exits the country, it settles with the American courts and is left with a stack of cash with which to pursue other projects. Given Mr Dudley's past comments, and Russia's importance as an oil province, it seems implausible. But if it did, where might BP go? Africa, where Shell is currently bidding for a position by taking over Cove Energy and others are keenly drilling, is one alternative. Another is the Middle East, where BP had its origins as the Anglo-Persian Oil Company. But deals with national oil companies in, say, Libya, Iraq or Kurdistan could be a case of out of the frying pan and into the fire.
Outcome 5: BP bid target?
BP's shares still trade at a discount to those of its peers two years after the Gulf of Mexico spill, reflecting both the uncertainty over US litigation and the endless squabbles in Russia. They also affect its ability to borrow; Societe Generale recently increased its weighted average cost of capital estimate by 50 basis points to 9.5 per cent as a result. RBC Capital reckons that the net effect of the Russian sale minus its Gulf of Mexico liabilities would leave BP as "the cheapest in the sector" on an adjusted enterprise/cash flow multiple of 3.1-3.2.
One way to close that gap would be for the group to be taken over, or broken up. There have been no hints from management that this is on the cards, and there would be major anti-trust implications if anyone such as Shell, ExxonMobil or Total attempted to do so. But the Chinese - in need of technology and not short of cash - might be tempted.
What next?
Bob Dudley and the BP board have come in for criticism from investors for failing to offer much in the way of strategic clarity; the proposed sale of the stake in TNK-BP will have done little to dispel this notion. It's possible, though unlikely, that BP may be in a position to comment on the sale process by 31 July, when it reports interim results. The outcome of the US legal discussions is unlikely to be known by then, either. So it looks as though investors will have to wait until the autumn before BP's fate becomes clearer.
