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Rosneft

At the center of Putin's oil plans is the colossus Rosneft.

Rosneft was a bit player when Putin assumed the presidency in 2000, but he adopted it as his baby and worked to bring it to a robust adulthood. He began building up the company with a forced buyout of minority investors. Next, he appointed Rosneft to be the government's representative in projects based on production sharing, a move that generated deal flow for the company.

With development of its domestic properties on track, Rosneft was ready to expand outside Russia, beginning with projects in Algeria and Kazakhstan. In four years, its production increased 50 percent, to 400,000 bpd in 2004. That was still small potatoes, though; at one point Rosneft had to fight a takeover by fellow Russian enterprise Gazprom.

Putin was in a hurry to show that his state company of choice was a force to be reckoned with and that anyone foolish enough to challenge it was risking a bloody nose. But it was taking far too long for internal growth to turn Rosneft into a dominant player. In 2004, Putin put Igor

Sechin in charge of Rosneft, and together they boosted the company to the top of the global energy heap.

Sechin is one of the "St. Petersburg boys," a trusted old confidant who followed Putin to Moscow. Known as tough, ruthless, and secretive, Sechin is thought to have worked as a spy in Africa and as the Soviet Union's primary arms smuggler for Latin America and the Middle East. With his background and his ties to Putin, he is the de facto leader of the Kremlin's siloviki faction, a sort of higher-level inner cabinet. They are a cadre of dedicated statists, for the most part former officers of the KGB, Chief Intelligence Directorate (GRU), and FSB. Their loyalty to Sechin may contribute to his considerable influence with Putin.

In any event, Sechin's purely political work—for 10 years he was deputy chief of the Putin administration—is likely less consequential than his economic accomplishments. As CEO since July 2004, he built the Rosneft we know today.

In July 2006, he took Rosneft "public" with an initial public offering (IPO) in London. I use quotation marks because only a quarter of the company was offered to outside investors; the rest of it stayed with or close to the Russian government, which is to say under Putin's control. Moreover, anyone holding publicly traded shares became instantly wealthy. It can't be proven, but it is widely suspected that Putin and Sechin are among those who got very, very rich.

Over the years, Rosneft frequently gobbled up small competitors and then moved on to a big target, TNK-BP, a vertically integrated company until 2012 owned by BP (formerly British Petroleum) and a consortium of Russian billionaires known as AAR. At the time, it was the second-largest oil producer in Russia and among the top 10 in the world.

TNK-BP had been a financial dream come true, paying billions in dividends to its owners—but it was also a business relations nightmare. The partners fought chronically. In 2008, Russian authorities arrested two British TNK-BP managers amid a dispute over strategy that forced then-CEO Bob Dudley to flee Russia—and that was just one of many partnership scandals.

The writing had been on the wall for TNK-BP since 2011, when one of the AAR billionaires quit as CEO of the venture and declared that the relationship with BP had run its course. After that, speculation was rife over who might buy in to take his place, but in retrospect the answer seems obvious: Rosneft, which might as well be called PutinOil. And the answer Rosneft provided was far bigger than the question.

It was a two-part deal. In the first part, Rosneft acquired BP's 50 percent share of the joint venture for cash plus Rosneft stock worth $27 billion. That gave BP nearly a 20 percent stake in Rosneft.

Why did BP go along? While Russia had been profitable for the British firm, management got tired of the drama within TNK-BP but still wanted to participate in developing the country's energy resources. The cash-and-shares deal gave BP a nice ownership stake in Rosneft— the best way to profit from Russia's immense untapped oil potential, because Putin will ensure that Rosneft has first dibs on all the juiciest opportunities.

In addition, the change placed BP personnel in regular, direct contact with Igor Sechin, Rosneft's CEO and Putin's trusted ally with a significant say in Russian energy policy. Anyone who wants to operate in Mother Russia has to have an inside track to the Kremlin. Otherwise, you are likely to find yourself kicked to the curb.

For his part, Putin knew he couldn't nationalize all of Russia's resources and go it alone. Extracting oil is difficult. Russia simply didn't have enough native oil and gas expertise. He needed BP.

Putin understood what the Saudis learned the hard way. When Saudi Arabia kicked out the foreigners and nationalized its oil industry in 1980, the country was producing more than 10 million bpd. Within five years, production had fallen to 4 million bpd.

So BP was encouraged to stick around and help Rosneft with technology to tap Russia's huge reserves of unconventional tight oil and shale gas. There was one further benefit: Having BP as a significant shareholder also lets Putin claim that Rosneft is not simply an arm of the government (and that he is not leading the country back into communism).

With BP accommodated, Rosneft could proceed with part two of the deal. It bought the other half of TNK-BP from the AAR group for $28 billion in cash. The oligarchs of AAR were motivated to sell, rather than stay in a joint venture with Rosneft. They'd had ringside seats for the Khodorkovsky/Yukos affair, and they knew they could easily meet the same fate if they tried to partner with Rosneft as equals. Why run that risk? Better to take the money and go.

In the end, it was the richest deal in the oil industry since Exxon bought Mobil in 1999. Rosneft emerged as the biggest (somewhat) publicly traded oil producer in the world.

Rosneft's rise to dominance of the Russian oil space has been spectacular. In 1998, the company produced a paltry 4 percent of the country's petroleum, with Lukoil the top dog at 17 percent and a crowd of small companies claiming the rest. Just 15 years later, in 2013, Lukoil remained healthy at 16 percent, but most of the little guys were gone, swallowed by Rosneft, which now accounts for 43 percent of Russia's production.

It would be hard to exaggerate Rosneft's position in the world. For perspective, this one company produces more oil than all of China and twice as much as Nigeria.

It's a state corporation with Putin's favor behind it, so Rosneft has vast potential for raising capital and enjoys an exalted place in the "too big to fail" category. It can continue to seek growth via acquisitions, either domestically or internationally, as well as organic growth from its operations across Russia and the Arctic shelf.

Rosneft combines the discipline of a publicly traded company with the backing of a powerful government. It has rich exploration potential to complement its immense production base. And it has the cash to gobble up oil assets when they come on the market anywhere in the world.

It's the perfect cornerstone for the grand plan to consolidate power in the hands of Russia's supreme ruler. Through Rosneft, Russia will gain the discretion to turn supply on and off and to raise and lower prices. Then Putin can play energy-needy countries against one another and squeeze Europeans to accept long-term, high-price contracts as the only way to secure reliable supplies. (See Figure 7.2 .)

Further, with Rosneft's acquisition capabilities, Putin has a tool to enhance Russia's influence in countries with resource potential that currently depend on Russian oil. Acquiring oil and gas reserves in such a country would let Russia dominate the customer's internal development as well as the flow of oil into or out of it.

Russia's Crude Oil and Condensate Main Export Destinations, 2012

Figure 7.2 Russia's Crude Oil and Condensate Main Export Destinations, 2012

Source: Global Trade Atlas, Energy Information Administration. © Casey Research 2014.

 
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