U.S. Sanctions Cloud Oil Discovery In The Russian Arctic With Uncertainty

Exxon Mobil’s (NYSE:XOM) joint venture partner in the Arctic exploration program, Rosneft, recently confirmed the discovery of oil in Kara Sea (a part of the Arctic Ocean north of Siberia). The commercial viability of producing this oil under current market conditions is yet to be determined but the size of the find (estimated at around 750 million barrels of oil) seems to be huge. While this is great news for both Exxon and Rosneft, the current geopolitical scenario, where the U.S. and European companies are being increasingly banned from cooperating with Russian peers, clouds the development prospects of these reserves with uncertainty. ^[1]

Exxon Mobil is the world’s largest publicly traded international Oil and Gas Company. It generates annual sales revenue of more than $420 billion with a consolidated adjusted EBITDA margin of ~14.7% by our estimates. We currently have a $107/share price estimate for Exxon Mobil, which values it at around 13.4x our 2014 GAAP diluted EPS estimate of $7.96 for the company.

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Exxon and Rosneft expanded their 2011 strategic cooperation agreement last year to include seven new blocks in the Russian Arctic in the Chukchi Sea, Laptev Sea and Kara Sea, spanning 600,000 sq. km. With this, both the companies agreed to cooperate in exploring and developing new hydrocarbon reserves in an area almost 190 million acres in size stretching almost halfway across the Arctic shoreline. 2D and 3D seismic surveys along with other data collection activities in the Kara Sea had been going on since then. The companies finally began drilling the first exploratory well in the multi-billion barrel University prospect last month. ^[2]

However, earlier this month, the U.S. government extended sanctions on Russia over the Ukrainian crisis. The previous round of sanctions only restricted the export of U.S. technology for Arctic and shale exploration, which did not prevent Exxon and Rosneft from starting to drill an exploratory well in the Arctic Kara Sea. However, the new set of measures were specifically targeted towards crippling the cooperation between Western and Russian energy companies in Arctic and tight oil exploration, as they required the removal of U.S. workers on these projects by September 26th.

Nevertheless, Exxon received a license from the U.S. Treasury Department allowing a slippage of up to 14 days beyond the sanctions’ deadline to enable a safe and responsible wind down of exploration activities. This implies that until the U.S. eases sanctions on Russia, Exxon cannot collaborate with Rosneft on exploration and development projects in the Arctic beyond October 10th. This creates a cloud of uncertainty over the development prospects of newly discovered hydrocarbon reserves in the Kara Sea since it would be difficult for Rosneft to accomplish this technically challenging project on its own. ^[3]

Exploration for new hydrocarbon reserves is a critical and capital-intensive function of all oil and gas companies. It takes years for these companies to conduct initial geological surveys and following exploratory and appraisal drilling activities before the actual development of oil and gas fields begins. Therefore, the immediate financial impact of the new Arctic discovery and fresh U.S. sanctions on Exxon would be limited. However, prolonged restrictions on exploration activities in the Arctic could prove detrimental to the company’s long-term growth prospects. At the end of last year, Exxon’s total proved hydrocarbon reserves stood at 25.2 billion barrels of oil equivalent, which is to say that the company held enough reserves to produce oil and gas for the next 16 and a half years at 2013 production rates. ^[4]

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1. Rosneft Discovered A New Hydrocarbon Field In The Kara Sea, rosneft.com [↩]
2. Exxon Mobil 2014 Analyst Meeting, exxonmobil.com [↩]
3. Exxon Winds Down Russian Drilling, wsj.com [↩]
4. Exxon Mobil 2013 10-K SEC Filing, sec.gov [↩]