Rosneft’s Deal With AAR Clears Way For Merger With TNK-BP

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Russian state-controlled oil giant Rosneft has finally reached an agreement with a the Russian consortium AAR to buy their 50% stake in the oil venture TNK-BP for $28 billion. The deal follows an agreement in October that Rosneft reached with BP Plc (NYSE:BP) to buy the other half of TNK-BP in a cash-and-stock deal valued at $27 billion. It also clears the way for the merger of TNK-BP with Rosneft by eliminating fears that the AAR may hold out and put the deal in jeopardy. The Rosneft-AAR deal is expected to be completed formally in the first half of 2013 after receiving approval from Russian and EU antitrust regulators. [1]

See our full analysis for BP

Why Is Rosneft’s Merger With TNK-BP Crucial For BP?

TNK-BP was initiated as a joint venture between BP and AAR, with BP buying a 50% stake in the venture for $8 billion. The operation has been highly lucrative, with BP receiving dividends totaling $19 billion from the project since inception, and accounting for 29% of BP’s total oil production last year. However, the venture has been marred by disputes between BP and AAR, a number of which have led to share price declines. [2]

The merger will make Rosneft the world’s largest publicly traded oil company. It will be able to produce more than four million barrels of oil a day, thus controlling about one-third of the total crude output of Russia. For its part, BP will eventually own a 20% stake in Rosneft and have two seats on its board. Also, given Rosneft’s powerful political ties, major projects are expected to come its way. Unlike its former troubled relationship with AAR, where the two sides clashed repeatedly over strategic and operational issues, BP seems to be sitting pretty. It stands to gain a significant chunk of nearly assured profits, assuming that Russia will continue to a dominant producer of oil and prices will hold. [3]

The cash BP receives from the deal, net of the purchase of additional shares in Rosneft, could be used to pay off a portion of the penalties relating to the 2010 Gulf of Mexico oil spill. The loss of dividends and equity affiliates oil production from the sale of its stake in TNK-BP will be partly offset by its 20% share of Rosneft’s profits, production and reserves. In fact, according to some estimates, the deal will see BP’s total reserves (including equity affiliates) grow 12.5%. For resource companies, the size of their reserves is a critical factor influencing valuation so BP could see an upside in its perceived value.

The political influence of the deal cannot be emphasized enough. BP has had a lot of unpleasant experiences with the Kremlin in the past, which is believed to keep a tight leash on the country’s strategically important oil and gas sector. So much so, that the current BP CEO Robert Dudley, who was heading TNK-BP previously, had to leave Russia in 2008. He had reportedly been under pressure from BP’s Russian partners and Russian authorities. The Rosneft deal aligns BP’s interests with those of the Kremlin, reducing its business and political risk significantly. [4]

We have updated our price estimate for BP to $43 based on the third quarter earnings release.

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Notes:
  1. Rosneft Seals TNK-BP Deal, WSJ []
  2. BP Switches Partners In Russia Through Sale of Stake In TNK-BP To Rosneft, Trefis []
  3. Rosneft to pay $55bn in TNK-BP takeover, Financial Times []
  4. Dudley Flees Russia in TNK-BP Shareholder Fight, Bloomberg Businessweek []
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