Statoil Tries The Hostage Strategy With Rosneft

|
 |  Includes: RNFTF, STO, XOM
by: Craig Pirrong

Very interesting of juxtaposition of stories involving Norway and Russia (h/t R).

Story one-Norway's Statoil and Russia's Rosneft agree to exploration joint ventures in the Russian Arctic:

Statoil (NYSE:STO) and Rosneft today signed a cooperation agreement. The companies have agreed to jointly explore offshore frontier areas of Russia and Norway and to conduct joint technical studies on two onshore Russian assets.

The agreement also envisages Rosneft's acquisition of participating interests in selected Statoil projects.

. . . .

Under the agreement, Statoil and Rosneft will set up joint ventures, with Statoil holding 33,33% in each. The partners will jointly explore the Perseevsky licence in in the Russian part of the Central Barents Sea and three licences - the Kashevarovsky, Lisyansky and Magadan-1 - north of Sakhalin island in the Sea of Okhotsk. The four offshore licences cover an area of more than 100,000 square kilometres, equalling approximately 200 blocks on the Norwegian continental shelf.

Are the Norwegians setting themselves up to be the next victims of expropriation? A couple of things to note.

First, this an exploration deal. Although this involves irreversible investments, the real risk of expropriation spikes when production begins. This is particularly true inasmuch as even if the exploration identifies commercially attractive opportunities. Rosneft would be in no position to try to freeze out Statoil after it had paid to discover the prospects because the Russian company seriously lacks the expertise to develop these resources itself: This is why it is so assiduously pursuing agreements with all the major western majors.

Second, it appears that Statoil is following the hostage model pioneered by ExxonMobil:

The cooperation agreement also provides Rosneft with an opportunity to acquire interests in selected Statoil exploration licences and assets in the North Sea as well as in the Norwegian sector of the Barents Sea.

This article, and all the others I've tracked down about the deal, are maddeningly short of details on this crucial aspect of the transaction. But it is evident that the deal is structured so that Rosneft has a valuable asset at risk if it (or the Russian government) tries its old tricks.

Note to reporters: please get a clue and get more detail on this aspect of the agreement. This is the crucial term in the agreement.

The hostage mechanism is an oft-used way of enforcing good behavior in transactions involving long-lived investments in specific assets. Williamson wrote about this mechanism in detail in The Economic Institutions of Capitalism and elsewhere.

The devil is truly in the details, though. XOM is apparently confident that it can provide incentives for good behavior from the Russians, and apparently Statoil has taken XOM's confidence to heart. But how it works in practice remains to be seen. Don't underestimate the ability of the Russians to behave opportunistically.

A particular risk is that the values of the investment opportunities in Russia and in Norway (or in the U.S. Gulf, in the XOM deal) diverge. Let's say that the Russian resource turns out to be extremely valuable, but the Norwegian (or Gulf) resource comes a cropper. Then the hostage has no value, and the risk of expropriation rises dramatically.

That risk seems to be particularly acute in this context, given the extreme uncertainty about the commercial value of the different projects. Much information will be developed over time about the value of the various resources. Moreover, technologies will change, affecting the commercial prospects of each. There is an appreciable risk of a divergence in hostage values. Given the asymmetric risk of opportunism, that divergence is particularly hazardous for Statoil and Exxon (NYSE:XOM).

This probably explains why all of the deals involve bundles of several exploration prospects. This diversification reduces the risk of the loss of hostage value. Only if all of the Norwegian prospects turn out badly do the hostages die, leaving Rosneft free to screw the Norwegians out of any attractive opportunities in Russia. Note in this regard that the Norwegian prospects are in two different regions-the North Sea and the Barents Sea. This increases the diversification.

Clever. I hope it works out for them.

Hey, Tim Newman- your insights would be greatly appreciated.

To emphasize why such measures are particularly important in dealing with Russia, consider the second story, about Russia banning Norwegian salmon imports:

Russia temporarily halted chilled salmon imports from 13 Norwegian firms, the animal and plant health watchdog in Moscow said.

The ban followed repeated instances of microbe pollution, a spokesman for the regulator said on Saturday.

Norway's food Safety Authority said on April 30 it had received advance notice of the ban, which does not include frozen salmon, and was working with the firms to resolve the "very serious" issue.

Russia is Norway's biggest salmon market.

Shares in fish and seafood products company Russian Sea . rose 7 percent in Moscow on Saturday.

. . . .

The global salmon market is experiencing a glut, and many firms are struggling to shift their stocks.

There are no "microbes" in salmon caught in Russian nets? Sure there aren't.

No. The last two sentences tell the real story. A supply glut is weighing on prices, hurting Russian fishers. So the Russians gin up (or would that be vodka up?) the "health and safety" issue to justify an import ban. Lo and behold, Russian fishing companies (or at least one, anyways, but there is no reason to believe it is exceptional) realize a windfall.

I've written in the past about how Russia routinely manipulates health and safety concerns as a protectionist instrument. (Search the site for "swine flu" and a couple of posts will come up.) (And yes, I recognize and condemn the fact that Russia is not the only sinner in this regard. The U.S. also engages in various forms of legerdemain to protect U.S. firms.) That this continues even as Russia joins the WTO indicates that it is still not too keen on rules and agreements that constrain its ability to take from foreigners to benefit domestic interests.

So, this fish story should focus Norwegian minds on the risks that they assume when trawling for other riches in cold waters. Maybe the hostages will keep the Russians in line. But the point is that you need hostages in dealing with them, for reputation and contracts alone aren't enough. You just need to hope that your hostages don't die before you need them.