DON'T DO IT

Having the world’s biggest publicly listed oil company won’t do Russia any favors

Obsession
Energy Shocks
Obsession
Energy Shocks

Over the past year, Russia has done a flurry of oil deals designed to resolve a long-term dilemma: It relies heavily on oil and gas revenue, but both the income and hydrocarbon production itself are projected to plunge. The deals are meant as a partial solution—to keep oil production at least at its current level of 10.3 million barrels a day. But if you look at events in the rest of the world, you get the impression that President Vladimir Putin’s latest steps—a $56 billion consolidation of Russia’s oil industry—may undercut his objectives.

The news is that state-controlled Rosneft on Oct. 18 submitted a bid for BP’s 50% share of TNK-BP, Russia’s third-largest oil company. That came two days after Rosneft signed a memorandum of understanding for the purchase of the other half of TNK-BP from another group. In both cases, Rosneft will pay about $28 billion. If the deals proceed, Rosneft will account for 43% of Russian oil production, and will surpass ExxonMobil as the world’s biggest publicly listed oil company in terms of output.

These blockbuster deals are meant to buttress the state budget. Taxes on oil and gas exports account for half of government spending—5.1 million barrels of oil a day, plus large natural gas shipments to Europe. But Europe’s gas appetite has been shrinking, supply competition has encroached from Qatar and elsewhere, and Russia has failed to nail down big new customers such as China. Meanwhile, the International Energy Agency is forecasting a decline in global oil prices over the next half-decade, and other analysts say the price plunge will continue through the 2020s.

In short, Russia faces a long-term cash crunch.

Although world oil prices are beyond his control, Putin has vowed to at least maintain Russia’s 10.3-million-barrel production pace. Part of his strategy has been to invite some of the West’s most competent oil majors—ExxonMobil, Norway’s Statoil and Italy’s Eni—to lead drilling efforts on the Arctic Sea and hydraulic fracturing of heavy Siberian oilfields. So far so good. If the Arctic can be safely cracked open, these are some of the companies that can manage it.

The problem comes with the next stage—Rosneft’s bid, three months in the making, for TNK-BP. The combined company would be responsible for maintaining and perhaps building on production of about 4.4 million barrels of oil a day. Oil work on that scale is a struggle even for the world’s biggest and most modern petroleum companies. There are doubts about Rosneft’s capacity to pull it off.

Leonid Fedun, a vice president of Russia’s publicly traded LUKoil, has suggested that in fact, creating an oil behemoth is not the best path to Putin’s goal. Fedun notes the surprising oil boom under way in Africa, one ignited not by oil giants, but a bunch of smallish wildcatters such as the UK’s Tullow Oil and the US company Anadarko. Fedun argues that this strategy—unleashing hungry small companies to hunt down Russia’s far-flung oil reserves, and not locking current sources of production and capital into a larger concern—is the smarter course.

Oswald Clint at Bernstein Research concurs. He cites the current US oil and gas boom. Russia’s oil industry is hobbled by waste, inefficiency and bloated size, and the lack of competition adds another problem. “US growth in oil is led by the smaller guys, and there are probably about 25,000 operators in North America and hundreds only in Russia, which again is a root problem,” Clint told me.

Oil consolidation CAGR
Mergers haven’t done much to increase oil firms’ output (Oswald Clint, Bernstein Research)

The small-big debate is not a Russian phenomenon, but global. As an experiment in 2007, Clint examined the aftermath of the great oil mergers of the late 1990s and early 2000s, when BP bought Arco and Amoco; Exxon bought Mobil; Chevron bought Texaco and Unocal; Total swallowed Fina and Elf Aquitaine, and so on. At the time, the companies promised impressive economies and performance improvements. The chart above shows the actual results, and the projected outcome for 2006 to 2010: an unimpressive 2.7% compound annual growth rate (CAGR) from 2006 to 2010. He has now repeated the exercise, and though we weren’t able to obtain the full data, he says the actual CAGR for that period has turned out to be a mere 0.1%.

Clint’s takeaway: “Big guys combining never leads to anticipated growth.” Rather than finalizing the acquisitions, Putin may want to let loose wildcatters on Rosneft, TNK-BP and other properties. He might have a better shot at solving Russia’s revenue dilemma.

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