Size Isn't Everything in Russian Oil

Πηγή: The Wall Street Journal
By LIAM DENNING
Nov 4 2012

The arrival of a new heavyweight usually unsettles smaller rivals—but not always.

Assuming Rosneft's $56 billion acquisition of TNK-BP happens, it would become the world's largest publicly traded oil-and-gas company by reserves and output. Its oil reserves and output will roughly match those of and BP combined.

But unlike diversified Western majors, the Russian state-controlled company's assets are concentrated in its own country. It hasn't competed aggressively for foreign oil assets in the way other national oil companies such as PetroChina have.

Nor is it likely to soon. Besides taking on more debt to buy TNK-BP, there is too much to do at home. While a decade of rising oil output and prices fueled the resurgence of the Russian economy and the Kremlin, a tougher future beckons. The International Energy Agency forecasts a slight decline in Russian oil output for the next two decades.

Even achieving this will require a step up in capital expenditure: $740 billion between 2011 and 2035. Russia's western Siberian fields—60% of the country's current output—are a declining Soviet legacy. Offsetting this with new fields in areas like the Arctic offshore will be challenging and, hence, expensive.

Lower exports and rising costs point to smaller margins for oil companies—and a smaller take for a state whose dependence on energy revenue has increased. Unless Russia can crack modernization and diversification for its economy, this represents a crisis in the making.

So a heavy burden rests on Russia's national oil champion to lead the charge in developing the country's next generation of resources. This was why Rosneft signed the original Arctic partnership with BP in 2011 that led to the TNK-BP deal. Indeed, for BP, the potential opportunity arising from Rosneft's need for foreign expertise is one rationale for selling its stake. Rosneft's need also lies behind other recent development deals with the likes of Exxon.

Bigger scale should help Rosneft take on some of these projects, especially in terms of getting financing in place and infrastructure built.

But further concentration of Russia's oil assets in large, state-backed firms raises concerns about efficiency. The stocks of Rosneft and its natural-gas counterpart Gazprom trade at persistent discounts to those of their Western and emerging-markets peers on price/earnings multiples, despite the companies' vast reserves.

Moreover, as a vibrant ecosystem of minnows and majors in much of the rest of the world demonstrates, the biggest companies aren't always the best tools for the job.

This is especially true because of Russia's need to enhance production from its older fields while also striking out for new frontiers. Elsewhere, it is often the smaller, nimbler companies that take on the mature fields from majors—who have bigger fish to fry—and squeeze more out of them. This has been the experience in older areas like the North Sea.

Smaller companies also have been at the forefront of America's shale boom. Unfortunately, Russia's longstanding tendency toward gigantism and state control saw larger oil firms swallow up smaller rivals over much of the past 15 years. Indeed, in "Wheel of Fortune," his new history of the post-Soviet oil industry, Thane Gustafson writes that small companies produce less than 5% of Russia's oil, and that share is declining.

Rosneft has partnered with Exxon to develop Siberian shale, but it remains to be seen whether two big integrated companies can replicate the success of the smaller U.S. exploration and production firms.

Rosneft's bigger scale is in some ways emblematic of the structural challenges faced by Russia's oil sector and economy. Far from being a threat, this latest shift in the landscape may represent an opportunity for western majors.