BP's Rosneft Investment Should Pay Off Handsomely

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Investopedia Advisor submits: As the world's top political and economic leaders gathered for their regular G8 summit last week in St. Petersburg, there was another, and perhaps more significant, sign that Putin’s Russia has finally arrived as a fully-paid member of the world's top economic club.

Even before President Bush stepped off Air Force One onto the tarmac at St. Petersburg’s Pulkovo airport, the sound of smartly shod footsteps could be heard around the Kremlin and the Russian Ministry of Energy as representatives of the world’s major energy players scrambled to get a piece of the Rosneft IPO.

More than half of the US $10.8 billion value of the issue was acquired by a bevy of global oil heavyweights, which included British Petroleum (NYSE:BP). BP took a US $1 billion stake, Malaysia’s state oil company Petronas grabbed a US $1.1 billion stake, and the China National Oil Company took a relatively meager US $500 million slice.

One other undisclosed bidder took US $3 billion according to Russian sources. All in all, the deal, which was Russia's largest ever IPO, generated enough interest that it was oversubscribed by 50%.

The Kremlin's energy czars must be beaming with pride at what has turned out to be well-timed PR coup designed to solicit a very public degree of support for Russia's new “petro-politics”.

So if the deal was a good PR move for “Mother Russia”, was it also a good deal for the companies buying into it? Absolutely.

Given Rosneft's huge reserve base of 18.9 billion barrels, the IPO participants have been able to acquire reserves at the exceptionally low price of US $4.20 per barrel. This is huge discount to the global average of new oil finding costs of around US $9 to $10 per barrel, and well below the US offshore finding cost of over US $27 per barrel.

To illustrate just how good the numbers were on this deal, consider how BP financed its purchase of Rosneft. Just prior to closing the Rosneft deal, BP sold off its 28% stake in the Shenzi oil field to Repsol (REP) for about US $2.2 billion. Based on a top-end estimate of proven and probable reserves in the range of 500 million barrels for the total field, BP sold its stake in Shenzi at a per barrel price of roughly US$15.70. Taking both deals together, it looks like BP pulled off a sweet reserve value arbitrage; selling high to buy low.

But, this wasn't exactly a riskless arbitrage, as the Rosneft deal carries some unwanted legal baggage as part of the bargain. Rosneft's main oil assets consist of the former holdings of Yukos, which were acquired by Rosneft for US $9.3 billion in 2004 after their earlier expropriation by the Russian government for alleged non-payment of taxes.

At the time, the move was widely regarded as a brazen act by the Kremlin to politically punish the free-wheeling former owner of Yukos, Mikhail Khodorkovsky, who made the mistake of openly opposing the Putin regime. Late last Friday, a U.K. court agreed to hear a legal challenge by former Yukos shareholders to block Rosneft's listing on the London stock exchange. A ruling in favor of the plaintiffs could block the start of trading in Rosneft shares in London, which is set to begin today.

Despite the complication of the Yukos legal issue, BP's Rosneft acquisition makes solid business sense. While it is Russia's third largest oil company, Rosneft is Russia's fastest growing oil producer, with annual production growing at about 10%. As the latest Yukos legal challenge is expected to fizzle out, some analysts even expect the company to pick up more choice assets from the battered carcass of Yukos, which is now in the early stages of a Russian bankruptcy process.

While there have been public statements from business leaders, including George Soros, denouncing what is seen as the state sponsored theft of assets, the Rosneft bidders were obviously less troubled about such minor ethical issues. As the Bob Dylan song goes: “money doesn't talk – it swears”.

By Eugene Bukoveczky, Contributor - Investopedia Advisor

Eugene Bukoveczky is a Chartered Financial Analyst (NASDAQ:CFA) and has broad experience in investment research and portfolio management. He has traveled extensively during his career, working in Toronto, New York, London and Dubai. He graduated from York University School of Business with an MBA.

Disclosure: At the time of release Eugene Bukoveczky owned no shares in any of the companies mentioned in this article.