Foreign and Defense Policy

Russia’s Last Chance to Transform Its Image?

Exxon Mobil and Rosneft—Russia’s largest oil company—signed an agreement this week to explore Russia’s potentially vast Arctic oil and gas deposits in the Kara Sea. The two companies plan to form a joint venture whose ownership will be divided 67/33 in Rosneft’s favor. They’ve also reaffirmed a deal signed at the Davos World Economic Forum last January to develop offshore deposits in the Black Sea. The initial investment for both projects—about $3.2 billion—will be borne almost exclusively by Exxon.

Exxon’s arrangement with Rosneft resembles an earlier, now defunct, agreement between Rosneft and British Petroleum (BP) to explore Russia’s Arctic shelf. But there are a few notable differences. The Rosneft-BP deal included a $16 billion share swap in which Rosneft would receive 5 percent of BP’s ordinary voting shares for 9.5 percent of Rosneft’s shares. Because Rosneft is state-owned, the Russian government would have become one of BP’s largest shareholders. The tie-up fell through, however, after a legal challenge from the co-owners of BP’s Russian subsidiary TNK-BP.

This week’s agreement between Exxon and Rosneft involves none of that. But it does entail an asset exchange. Rosneft might acquire minority stakes in drilling operations in the Gulf of Mexico and Texas. For the Russians, cooperation with the world’s top oil producer brings both an intangible sense of prestige and a more practical expectation that Rosneft will be able to tap Exxon’s technological prowess. They realize that Rosneft and other domestic producers aren’t capable of extracting oil from Russia’s offshore deposits and even some of its rapidly maturing onshore fields.

And the agreement looks like a win for Exxon too. While BP fought strenuously to prevent its agreement with Rosneft from collapsing, other supermajors—including Royal Dutch Shell and Chevron—had reportedly expressed an interest in exploring the Kara Sea, which, according to Rosneft, contains 36 billion barrels in recoverable oil reserves and 110 billion in total.

Yet working in one of Russia’s “strategic industries” comes with serious risk—something Exxon undoubtedly realizes. In 2006, the Kremlin essentially coerced Shell into selling a major stake in its $22 billion Sakhalin Island oil and gas project to Gazprom. Exxon is part of a consortium that’s developing a sister project on the island. And on Wednesday, the day after Exxon and Rosneft signed their Arctic agreement, masked commandos raided BP’s Moscow offices. The raid was apparently associated with a lawsuit filed against BP by TNK-BP’s minority shareholders.

But, for Russia, it’s difficult to overstate the importance of the Exxon deal. Further expropriations, forced sales, or other incidents that highlight the country’s flimsy rule of law and perilous business climate will inevitably scare off the foreign direct investment that Russia desperately needs. If it’s kicked out or isn’t allowed to profit fairly from investments Exxon won’t be doing business in Russia any time soon—and neither will any other major foreign oil company. This could be Russia’s last chance to transform its image as one of the world’s most inhospitable destinations for foreign capital.

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