Significance: The agreement represents a major new commitment to Russia by BP, which is effectively doubling down on its existing presence in Russia as the company continues to divest assets elsewhere around the world in order to generate cash to pay for its liabilities from the Macondo oil spill in the U.S. Gulf of Mexico last year.

Implications: BP's CEO Bob Dudley, who just three years ago was effectively forced to leave Russia as part of the spat between TNK-BP's shareholders, called the agreement between BP and Rosneft "a new template for how business can be done in our industry". He also noted the alignment of interests that has been achieved via the cross-shareholding deal between the British multi-national oil firm and the Russian national oil company.

Outlook: BP's brash deal with Rosneft could give the U.K.-based oil firm a new lease of life following its disastrous oil spill last year, but BP's decision to bet the house on Russia could spell further trouble for the company in the United States.

BP Maps Out a New Future

In the nearly nine months since the blowout of the MC-252 oil well and the sinking of the Deepwater Horizon rig in the U.S. Gulf of Mexico led to the worst oil spill in U.S. history, BP mainly has been engaged in divesting assets and shrinking its project portfolio in an effort to raise cash to pay for the clean-up operation and to gird itself for expected future liabilities. As the U.K. supermajor has sold off assets elsewhere around the world, BP's operations in Russia have become, by default, more important to the company's overall growth and development strategy. In some cases, BP has even sold some assets to its Russian joint venture (JV), TNK-BP, allowing BP's Russian partners in the JV to achieve their own expansion ambitions, all the while generating cash for BP and permitting the company to retain a stake (indirectly) in these assets.

On Friday (14 January), however, BP sought to draw a line under its Macondo troubles, announcing a landmark agreement with Rosneft that is geared to put the U.K. firm on a path to secure its future. BP's direct investment in TNK in 2003 to form TNK-BP was ground-breaking in its own right, but this time BP may have one-upped itself, announcing an arrangement with the state-run Russian oil company that will see the two firms swap shares and create a strategic exploration alliance to carry out exploration and development of three licence blocks on the Russian Arctic continental shelf. Under the agreement, announced at a news conference in the U.K capital, London by BP CEO Bob Dudley and Russian deputy prime minister Igor Sechin, BP will receive 9.5% of Rosneft's shares (giving BP a 10.8% overall stake in Rosneft) in an all-share swap deal that gives Rosneft 5% of BP's ordinary voting shares. The two companies also agreed to explore and develop the EPNZ 1, 2, and 3 licence blocks in the South Kara Sea that were awarded to Rosneft in 2010. The three blocks cover approximately 125,000 sq. km, an area roughly equivalent in size and prospectivity to the U.K.'s North Sea.

Dudley hailed the agreement as "a new template for how business can be done in our industry", adding that, "This unique agreement underlines our long-term, strategic and deepening links with the world’s largest hydrocarbon-producing nation. We are very pleased to be joining Russia’s leading oil company to jointly explore some of the most promising parts of the Russian Arctic, one of the world’s last remaining unexplored basins". Sechin, also the chairman of Rosneft, noted that the deal includes a commitment by both companies to seek additional opportunities for international collaboration beyond their 50:50 partnership at Ruhr Oel, the German refining venture in which Rosneft joined BP in October of last year after reaching a deal to buy out PDVSA's stake. Eduard Khudainatov, Rosneft's president, praised the deal with BP as a step forward for implementing Russia's offshore strategy, adding that the new Arctic JV "will utilise the experience and expertise of BP" to grapple with a project that is "unique in its complexity and scale both for Russia and the global oil and gas industry".

Concerns and Opposition Abound

The new BP-Rosneft cross-shareholding arrangement certainly breaks new ground in terms of an IOC-NOC partnership, but it is BP's recent track record that has environmentalists up in arms about the company's plan to explore in the South Kara Sea. News of the deal generated a strong rebuke from Greenpeace, which issued a statement citing the fragility of the Arctic environment saying, "It seems that company learned nothing last year in the Gulf of Mexico". Russian officials and BP executives clearly feel otherwise, however, with some suggesting that BP's experience with the Macondo spill means it now has a "comparative advantage" vis-a-vis other oil companies when it comes to capping deepwater spills and applying best operating practices. Rosneft and BP have agreed to establish an Arctic technology centre to ensure the safe extraction of hydrocarbon resources from the Arctic shelf.

Nevertheless, there was a visceral, immediate reaction from some U.S. politicians to the news of BP's new Russian alliance, coming hard on the heels of the release from U.S. president Barack Obama's National Commission panel investigation into the Macondo spill recommending a moratorium on Arctic drilling. Edward Markey, the top Democrat on the House of Representatives Natural Resources Committee, called for the deal to be investigated by the Committee on Foreign Investment, saying derogatively that "BP once stood for British Petroleum. With this deal, it now stands for Bolshoi Petroleum". Michael Burgess, a Republican member of the House Energy and Commerce Committee, said that the deal "deserves some analysis and scrutiny", noting the potential national security implications considering BP's ownership of several critical oil infrastructure assets in the United States, such as the Trans-Alaska pipeline. BP was also the top petroleum supplier to the U.S. military in 2009.

The Obama administration has yet to comment on the BP-Rosneft arrangement, but the perception that BP is reorienting its focus to Russia and away from the United States, post-Macondo, is sure to put further strain on BP's relations with the U.S. government. By contrast, U.K. secretary of state for energy and climate change, Chris Huhne said that the arrangement was "groundbreaking", adding that it was "good news for Europe, for the U.K,'s energy security and worldwide". Russian prime minister, Vladimir Putin also gave his blessing to the deal, which was only announced after Dudley flew to Moscow after first meeting with Putin earlier on Friday to secure the powerful Russian prime minister's approval of the deal.

Outlook and Implications

For BP, the Rosneft share swap and Arctic exploration alliance represent a turning point for the firm as it embarks on a future that no one could have possibly foreseen one year ago. In spite of the Macondo experience and at the same time because of it, BP is betting that its relationship with the Russian government, which has often been fraught with problems, will now be its saviour. Just as BP opted to partner with TNK after first battling with the Russian firm over Sidanco, now the U.K. supermajor is once again choosing to align itself with the Russian state (via Rosneft), just a few short years after a TNK-BP shareholder dispute (aided and abetted by Russian authorities) threatened to tear that JV apart. BP's view in Russia seems to be: if you can't beat 'em, join 'em.

BP and Rosneft said that the share-swap deal, estimated to be worth nearly US$16 billion, should be completed in a matter of weeks. Although both the U.K. and Russian governments are already on board, there are several potential flies in the ointment to a smooth implementation of this so-called "model arrangement". Alfa-Access-Renova (AAR), BP's erstwhile partner behind TNK-BP, has raised questions about whether BP's deal with Rosneft violates the terms of the TNK-BP shareholder agreement between BP and AAR. Stan Polovets, chief executive of AAR, said that the terms of the TNK-BP shareholder agreement say that "all new business opportunities in Russia and Ukraine must be pursued through TNK-BP", meaning that the BP-Rosneft deal would violate these terms. BP, however, said it was confident that this issue would be resolved in a "businesslike way".

BP clearly feels that it has a trump card to play with AAR, should it come to that, now that the U.K. supermajor has reached an agreement with Rosneft. Speculation is already swirling that Rosneft will buy out AAR and join BP as a joint shareholder in TNK-BP now that BP has essentially outmanoeuvered AAR in striking its own partnership directly with the Russian state. For Dudley, who was essentially kicked out of Russia in 2008 by the Russian oligarchs behind AAR who thought that he was steering TNK-BP in the wrong direction, getting Rosneft to kick out AAR from TNK-BP would no doubt be sweet revenge. On the other hand, lest everyone get ahead of themselves in crowning BP for its deft strategy, it is worth noting that a similar "strategic alliance" between BP and Gazprom, announced in June 2007 in conjunction with a deal to sell TNK-BP's stake in the Kovykta field to the Russian gas giant, has come to nothing. Furthermore, BP and Rosneft have already partnered to jointly explore off Sakhalin Island in Russia's Far East, with virtually nothing to show from it. Finally, there is also the prospect that BP is simply jumping out of the frying pan and into the fire by tying its fortune to Rosneft. BP has its own baggage with the Macondo liabilities that Rosneft will now help carry, but the Russian oil major itself is still haunted by the ghost of Yukos.

Shareholders in the now-defunct Russian oil company are pressing for restitution from Russia in a US$98-billion lawsuit in the European Court of Human Rights, and recently a string of foreign court rulings have gone against Russia. In a potentially ominous statement, Yukos spokeswoman Claire Davidson said, "BP shareholders should be concerned that once again the company has invested in a deal with Rosneft in assets over which there is a significant question as to security of Rosneft's ownership". A cross-shareholding partnership may be a new model for IOC-NOC co-operation, but the Rosneft-BP alliance has many potential problems to overcome in order to become the success that the two companies are betting on.