Get the latest updates as we post them — right on your browser

. Last Updated: 07/27/2016

Gazprom Gets Kovykta on the Cheap

ReutersAn aerial view of a production station at the enormous Kovykta gas field in the Irkutsk region in eastern Siberia.
Gazprom bought TNK-BP's stake in the troubled Kovykta gas field for a knockdown price Friday in a landmark deal that ends years of wrangling over BP's flagship project in Russia.

The buyout underlines the Kremlin's determination to consign foreign oil firms to the role of secondary partners in the country's energy sector. Plans for an investment partnership among Gazprom, BP and TNK-BP, which were signed as part of the deal, could help Gazprom overcome Western resistance to its ambitions abroad.

TNK-BP agreed to sell its 62.9 percent stake in Rusia Petroleum, which holds Kovykta's development license, to Gazprom for just $700 million to $900 million -- a paltry sum for a majority share in a project due to be worth some $20 billion when it is completed.

The agreement was signed at a Kremlin ceremony overseen by First Deputy Prime Minister and Gazprom chairman Dmitry Medvedev, who is a leading contender to succeed President Vladimir Putin.

Neither Putin, who has made scathing remarks about TNK-BP's acquisition of the Kovykta license and stewardship of the field, nor BP's new chief, Tony Hayward, attended the signing.

Buoyed by record high oil prices, Putin has stepped up the drive to bring oil and gas reserves back into the folds of the state as his presidential term nears its end in March 2008.

Friday's deal left the ultimate fate of TNK-BP, a 50-50 joint venture formed between BP and a trio of Russian oligarchs in 2003, undecided.

The Russian shareholders -- Mikhail Fridman's Alfa Group, Viktor Vekselberg's Renova and Len Blavatnik's Access Industries -- can opt out of the partnership at the end of this year. Gazprom has said it would like to buy them out, but TNK-BP publicly denies any negotiations on the issue with the state-run gas giant.

Vladimir Suvorov / Bloomberg
TNK-BP CEO Robert Dudley
"This historic agreement lays the ground for powerful cooperation between BP, TNK-BP and Gazprom," Hayward said in a statement released after Friday's signing.

The deal gave TNK-BP the option to buy back a blocking stake of 25 percent plus one share in Rusia Petroleum at an independently verified market price. The call option will come into force once the final sale agreement is signed within three months, and will be valid for one year.

In addition to Kovykta, a giant field in eastern Siberia estimated to hold 1.9 trillion cubic meters of gas, Gazprom also formed a strategic alliance with BP that should ease its entry into the British market.

The two companies and TNK-BP signed a memorandum of understanding to look for investment opportunities of at least $3 billion, in Russia and abroad.

Robert Wine, a BP spokesman in London, said the joint venture would involve "a probable asset swap somewhere around the world," but provided no further details.

Mikhail Fomichev / ITAR-TASS
Gazprom chief Dmitry Medvedev
Gazprom would likely look at BP's downstream assets in Britain and elsewhere, analysts said. Putin has stressed the principle of "strategic reciprocity," saying that Russian companies should be rewarded with equity in other countries in exchange for allowing foreigners to operate in Russia.

"We are happy to be in Russia," Wine said. "An important part of our future strategy is to make the most of what we can in Russia."

The country is key to BP's growth, with TNK-BP accounting for one-quarter of its output and one-fifth of its reserves.

"The rules of the game are very clear now in Russia and BP understands that," said Joseph Stanislaw, an independent senior adviser to Deloitte & Touche.

"A piece of a very big field is better than no piece at all," he said.

Putin has made it clear that foreign involvement in the strategic energy sector will be limited to 49 percent. A much-delayed law enshrining the concept is due to be passed by the end of the year.

"Now there are no big projects that are in violation of the new subsoil [bill] and we can expect to see progress" on it being passed, said Chris Weafer, chief strategist at Alfa Bank.

The dismantling of Mikhail Khodorkovsky's Yukos, once the country's largest oil firm, and Gazprom's entry into Sakhalin-2 last year, have decisively swung the balance of power in the energy sector back toward state ownership.

Friday's deal also appeared to put to rest the licensing troubles surrounding Kovykta. The Natural Resources Ministry had accused TNK-BP of producing too little gas at the field. TNK-BP argued it could not produce the 9 billion cubic meters per year stipulated in the license since Gazprom had blocked construction of a pipeline to China and local demand was insufficient. TNK-BP had lobbied for years for the license to be amended.

A ministry spokesman said Friday that the body was ready to review the Kovykta license and could change the terms by the end of next week.

"As the ownership of the field has changed, we are ready to consider changing the license," spokesman Rinat Gizatulin said. "We are ready to listen to Gazprom."

In December, Shell ceded its controlling stake in the Sakhalin-2 project to Gazprom after ministry officials threatened to revoke its license over purported environmental violations.

At a Kremlin meeting announcing the sale in December, Putin declared that all environmental problems had been resolved.

The Kovykta field did not fall under TNK-BP's publicly traded holding, but was seen as a bellwether of the company's future activities in Russia.

BP and TNK-BP went to some lengths to put a positive spin on the loss of Kovykta, which is expected to be a key source of gas supply to the lucrative Chinese market.

"This is an important development in the future growth of TNK-BP," the company's CEO, Robert Dudley, said in a statement. "We look forward to broadening our working relationships with Gazprom and BP and to further developing our Russian asset base."

BP had long been seeking to appease the government in a bid to hold on to Kovykta. It sank $1 billion into state-controlled Rosneft's initial public offering last July and was criticized for agreeing to take part in auctions of Yukos assets earlier this year.

The $700 million to $900 million price tag is well below the stake's value, analysts said. TNK-BP has already put $450 million into the field, which is at the earliest stages of development, producing less than 1 bcm per year.

"There is disappointment with the valuation [of Kovykta], but it's been very difficult to be precise as to how much the project is actually worth," Alfa Bank's Weafer said. "For BP, they will view this as the cost of getting better entry into the game."

BP initially bought into the field in 1997, paying $571 million for a 10 percent stake in Sidanco, which in turn held a 60 percent stake in Rusia Petroleum and was eventually folded into TNK-BP.

In a briefing with foreign media representatives earlier this month, Putin attacked international and private Russian oil firms for using illegal means to acquire production licenses in the country.

"I am not even going to talk about how they obtained this permit," Putin said of TNK-BP's license for Kovykta. "We will let it rest in the conscience of those who did this at the beginning of the 1990s."

Referring to Shell's agreement to develop Sakhalin-2, signed in 1994, he said it was one example of "situations that were clearly beyond the pale of the law."

Gazprom and Rosneft have emerged as the biggest winners in Putin's strategy of retaking control of key energy reserves.

A Gazprom spokesman said Friday the company was not in talks to buy out Rusia Petroleum's other two shareholders, Vladimir Potanin's Interros holding and the Irkutsk regional government.

TNK-BP also sold Gazprom its 50 percent stake in East Siberian Gas Company, the company carrying out Irkutsk's re-gasification in conjunction with the regional government, as part of Friday's deal.

Weafer said the agreement played out well for both BP and Gazprom.

"This deal will allow Gazprom to grow its international presence without running into the political slack and negative reaction it has faced in recent years, especially in the U.K.," he said.

Earlier this month, outgoing British Prime Minister Tony Blair warned that increasingly frosty relations between Russia and the West would harm foreign investment in the country.

Tim Lambert, vice president at British energy consultancy Wood Mackenzie, said Russia's image would have been harmed more if the Natural Resources Ministry had followed through on threats to revoke TNK-BP's license.

"It's good that it has been resolved without revocation of the license," he said. "That would have been a blow."

Representing TNK-BP at Friday's meeting were Dudley and Vekselberg, who also heads TNK-BP's gas business. James Dupree, a BP vice president, also attended.

Staff Writer Anatoly Medetsky contributed to this report.