September 10, 2011

Exxon in Exploration Deal for Russian Arctic

The New York Times reports on the deal Exxon Mobil signed in late August with the Russian company Rosneft to explore for oil in the Russian Arctic Ocean. The companies are swapping assets, including Exxon claims in Texas and the Gulf of Mexico, but the overall size of the potential investments at stake is uncertain. Russian Prime Minister Vladimir Putin suggested that the amounts could be as high as $500 billion; Exxon said the initial investments would likely be in the tens of billions; and the fact sheet announcing the deal put the initial commitment at $3.2 billion for exploration in the Kara Sea.

For Exxon, which is America’s largest company and is a spinoff of the original Standard Oil, the deal means wading deeper into Russia’s risky business environment. As a result of the agreement, which is almost certain to require a review in Washington, more of the company’s investments and future earnings will partly hinge on policies set in the Kremlin.

Russia has reneged on deals with Western oil companies before. In 2006, for example, it compelled Royal Dutch Shell to sell 50 percent of a Sakhalin offshore development to Gazprom, a state company — after Shell spent a decade and more than $20 billion of its own money and that of other investors to build the project’s infrastructure. . . .

Under the new agreement, the state-owned Rosneft could become a part-owner of drilling operations in the United States. Those operations could include two of the industry’s most contentious oil extraction methods — drilling for oil in the deep waters of the Gulf of Mexico and using the so-called hydraulic fracturing, or fracking, technique on land. The Russians want to learn about both types of drilling for use at home.

The Rosneft deal would also be among the most significant attempts by a company from a country that is not an American ally to acquire United States oil fields since Cnooc, the large Chinese oil company, tried to buy the California oil company Unocal. Although it was not formally banned, that deal fell apart in 2005 after members of Congress criticized the potential Chinese ownership of American oil assets. . . .

Russia’s economy is dependent on petroleum for about 60 percent of its export revenue. Policies here are also important for world oil supplies, as Russia now pumps more oil than Saudi Arabia. Yet Russia’s onshore fields in Siberia are in decline, threatening the prosperity and geopolitical clout that has come with oil wealth in the last decade. . . .

Once seen as a useless, ice-clogged backwater, the Kara Sea now has the attention of oil companies. That is partly because the sea ice is apparently receding — possibly a result of global warming — which would ease exploration and drilling. . . .

In the waters off Alaska, drilling has remained largely off limits because of environmental restrictions and lawsuits by conservation organizations.

Rosneft’s attempt to strike a similar pact with BP this year fell apart because the British company had a joint venture with a separate group of private Russian investors, who blocked the Rosneft deal in an international court. The collapse was an embarrassment for Mr. Putin, who had endorsed the BP-Rosneft deal. After the failure of that deal, the onus fell on Russia to demonstrate it could uphold an agreement, Mr. Kupchan, the analyst, said. “They got away with BP, because the deal was seen as BP having two Russian wives,” he said. Exxon, in contrast, has no exclusivity clause with a competitor in Russia that could come up in court.

Still, if Rosneft’s participation in American projects leads to objections in the United States, Exxon’s investment in Russia could also be vulnerable. Russian officials say reciprocity, or mutual dependence, is a condition for foreign investment in their petroleum fields. . . .

For Russia, the agreement is a result of a new openness to foreign investment in its oil industry that is meant to address the declining output in Siberia. The Kremlin opened discussions last year with Western oil companies whose prospects on the other side of the Arctic Ocean — above Alaska and Canada — had at least temporarily dimmed with the moratorium on offshore drilling in the aftermath of BP’s oil spill in the Gulf of Mexico.

This summer, the American Interior Department eased the restrictions somewhat by granting Royal Dutch Shell conditional approval to drill exploratory wells in the Arctic Ocean off Alaska’s coast starting next year.

But American and Canadian regulators worry about the special challenges in the Arctic. The ice pack and icebergs pose threats to drilling rigs and crews. And if oil were spilled in the winter, cleanup would take place in the total darkness that engulfs the region during those months.

Still, the United States Geological Survey estimates that the Arctic holds one-fifth of the world’s undiscovered, recoverable oil and natural gas.

Igor Sechin, Russia’s deputy prime minister responsible for energy, said that the agreement anticipated $200bn-$300bn in direct investment over ten years, according to the FT.

“One ice-proof platform costs $15bn minimum” he said. “For the Kara Sea, we require at least 10 platforms.” He declined to say when the first oil could be expected.

Rosneft shares rose 12.5% in the three trading days before the deal was announced, prompting an “investigation” by Russian authorities. 

Christopher Jones, at Climate Progress, notes the irony that Exxon, which has funded numerous climate skeptics, should make such a large foray in an area now "prospective" because of global warming.
Large deposits of gas and oil have been known to exist in the Arctic Ocean for decades. So why did they make this deal now? One key thing has changed: the arctic ice is melting rapidly. The Kara Sea has typically been covered by ice floes nine months of the year or more, making commercial development of its resources unprofitable. But for the last several years, the extent and duration of the arctic ice has been diminishing, a phenomenon the vast majority of scientists believe to be caused by climate change. Suddenly, oil and gas exploration in the Arctic Ocean is looking far more attractive. Exxon has realized that a warming planet offers some new opportunities for profit and is adjusting its strategic decisions accordingly.
The deal also illustrates the limitations of national legislation in restricting drilling in contested areas like the Arctic (or deep offshore). Faced with restrictions in one area, the oil companies just move elsewhere. The same phenomenon occurs with regard to consumption and takes the form of "outsourcing emissions" via "offshore manufacturing."

Both parties doubtless felt keenly the risks of defection from the other side, with the very real possibility that their partner might back out (or be forced to back out) at some point in the future. That's why they exchanged hostages. Five or ten years from now, however, the relative costs of such defection might look very different.


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