BP‘s (LSE: BP) (NYSE: BP.US) troubled — though generally profitable — relationship with Russia could be about to take another uncomfortable turn.
Just over 18 months ago the company pulled off something of a coup, swapping its share of a 50/50 joint venture in TNK-BP for a near 20% stake in an enlarged state-owned Rosneft, which bought out TNK. BP got out of a troublesome relationship with a couple of oligarchs and acquired what Russians call krysha — the protection of the state, invaluable in a country where the rule of law is decidedly shaky.
Economically, that has proved a great move: Rosneft contributed nearly a third of BP’s second-quarter profits. In 2012 Western politicians were encouraging economic integration with Russia, and getting into bed with the state looked like de-risking.
Now that has come back to bite the company. Sanctions against Russian state entities and businessmen close to President Putin, and a ruling by the International Court of Arbitration over the dubious means by which Rosneft acquired its assets, could both hit BP.
In fact, I think there are three Russian-related threats hanging over the company.
Earnings
First, the sanctions will ban technology transfer in parts of the energy sector — part of the commercial rationale of BP’s investment in Rosneft. They will also inhibit access to Western lending and capital markets for Russia’s state banks: that’s bound to have a knock-on effect on Rosneft’s funding. Its CEO Igor Sechin — a close ally of Putin and himself subject to US/EU sanctions — has admitted that some projects will have to be delayed. Sanctions will put downward pressure on production and earnings.
Valuation
Secondly, I suspect that intensifying sanctions could undermine BP’s accounting treatment of Rosneft as an associate. That treatment depends on the supposition that with a 19.75% shareholding and two board members it has ‘significant influence’ over Rosneft. It was always contentious whether BP would have any real influence: can it really now claim to have significant influence over a company treated as a pariah in the West, whilst also still fighting a rearguard action in the US over the Deepwater Horizon liabilities? Without associate status, BP would just account for dividends paid by Rosneft. It would not affect BP’s prodigious cash flow, but it would lose its share of Rosneft’s earnings and reserves, affecting its valuation.
Seizure
Thirdly, the Court of Arbitration in The Hague has ruled that Russia must pay $50bn in compensation to the former shareholders of oil giant Yukos, which the government forced into bankruptcy in 2004. Yukos’ assets were acquired — cheaply — by Rosneft. Russia has rejected the Court’s findings, but the ruling could potentially permit the litigants to seize overseas state-related assets — and conceivably, that could include BP’s shares in Rosneft. Referring to BP, their spokesman said: “It is safe to say that nobody is safe. We will look at everything.”
BP’s shares are trading at a discount to Shell‘s, but there is really no satisfactory way of valuing such uncertainty.