Russia Likely to Open Arctic to Private Development (XOM, BP, STO)

In an interview with the Financial Times, Vagit Alekperov, CEO of Lukoil said that Russia’s policy of retaining all its rights to offshore development of what are believed to be vast reserves of oil and gas inside the Arctic Circle will be abolished because it has “yielded no positive results.” Under current law, only natural gas giant Gazprom and national oil company Rosneft are allowed to license resources in the Arctic.

Alekperov said, “State companies take the licences and do nothing with them.” What he hopes for, and what Russian President Vladimir Putin also hopes for, is that they can lure the expertise of companies like Exxon Mobil Corp. (NYSE: XOM), BP plc (NYSE: BP), and Norway’s Statoil ASA (NYSE: STO) back to Russia with the promise of advantageous tax laws and royalty agreements.

Whether or not the plan works depends to a large extent on the size of the bait. Exxon has been stifled by Gazprom at attempts to build a pipeline from its Sakhalin project to China and BP’s joint venture with TNK was effectively broken up by the Putin government. Luring the big oil companies back will require something more effective than a promise that the companies will eventually get paid.

Russia needs these foreign companies both to finance what are sure to be massively expensive work and to develop the technology to recover the resources. Russia’s Arctic could well offer the most inhospitable climate on earth, along with as much as 20% of the world’s undiscovered oil and gas resources. Exxon last year formed a partnership with Rosneft to explore a part of the region, but results could be years away.

And that is the nub of Russia’s problem. The country is committed to producing 10 million barrels/day of liquids through 2020, and the only way that can happen is if the country can bring new fields into production.

Lukoil’s chief is unhappy that Russian law prohibits his company from bidding on or participating in licenses to the Arctic. He also supports a change to the country’s tax law on oil, which currently taxes production not profit. Russia is looking at a variable-rate tax law that would overcome his objections, and Alekperov claims that the proposed law has Putin’s support.

Russia needs crude oil prices of around $117/barrel to balance its government spending — and even if the country can achieve that, the revenue cannot be reduced by the capital spending required to explore and develop the Arctic. Cash and technology are what Exxon, BP, Statoil, and others will be expected to provide. Russia only wants the lion’s share of the profits.

Paul Ausick