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Good, Vague Intentions from Exxon and Rosneft

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Russia's latest big oil deal offers less than meets the eye, but signals the country's strategic importance.

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That didn't take long. Less than four months ago, global oil giant BP (BP) was forced to walk away from an alliance with Russian state company Rosneft that could have led to decades worth of drilling in the Arctic. BP's leadership forgot that they already had an exclusive alliance with Russian joint venture TNK-BP. Yesterday Exxon Mobil (XOM), the one oil company that can make BP look small, unveiled its own tie-up with Rosneft along similar lines.

Prime Minister Vladimir Putin rolled out the red carpet for Exxon CEO Rex Tillerson during a surprise signing ceremony at Sochi, the Kremlin's Black Sea summer home and Olympic site-to-be in 2014. Russia's supreme leader said the newly minted Kremlin-Texan partnership could eventually invest up to $500 billion on the petroleum-rich northern frontier, a number he found "scary" to think about. (And we thought Putin wasn't scared of anything.)

Tillerson, for his part, promised to open the gates of America to Rosneft, at least a crack. Exxon will offer the Russians equity stakes in at least a half dozen projects in North America, emphasizing those like offshore or "tight" oil where Rosneft is hungry for technology transfer.

History may prove this to be the landmark mega-accord Putin implied, keeping both Russia and Exxon at the top table of global energy providers well into the 21st century. But for now it looks like a trade between sports teams where all the players are to be named later. "Now that the initial euphoria is dying down this looks more like a letter of intent than an actual deal with a contract," says Valery Nesterov, an oil analyst at Troika Dialog in Moscow. The market's snap judgment was positive for Rosneft, whose London shares jumped 7 percent on the news, and underwhelming for Exxon which stayed flat.

To start, Exxon's numbers are orders of magnitude lower than Putin's. The company committed itself to spend just $2.2 billion -- pocket change in supermajor terms -- poking around under the ice in the Arctic's Kara Sea, plus $1 billion more on the Black Sea shelf. Tillerson put the upper end of possible investment in the "tens of billions," significant even for Exxon but not a corporate life-changing event.

Ifs, ands, or buts around the alliance are legion. For starters, no one knows even approximately how much petroleum is lodged in the Arctic. French oil major Total (TOT) recently came up with an estimate of just half the prevailing one from the U.S. Geological Survey, Nesterov says, and of that diminished lode 80% is likely gas rather than oil. Returns on investment depend on adjustments to the Russian tax code, which currently soaks crude oil producers to the point of disincentive. U.S. politicians are not likely to remain quiet about Russians grabbing a share of our own resource base. Oil watchers will remember that China National Offshore Oil Company (CNOOC) had to give up its agreed $18 billion purchase of California's Unocal in 2005 after a storm of Congressional indignation.

That is all before broaching the essential question of whether Russia's government can be trusted as a business partner over a span of decades. Exxon's own experience gives reason for doubt. The American company has operated Russia's largest single foreign investment off of Sakhalin Island in the North Pacific since 1996. The Kremlin has threatened to hold up the project a few times thanks to alleged cost overruns. State behemoth Gazprom forced Exxon to sell Sakhalin's gas to it rather than directly to hungry Asian consumers. Global oil rivals Royal Dutch Shell (RDS-A), ConocoPhillips (COP), and Chevron have all abandoned $1 billion-plus projects in Russia in recent years for geological or political reasons.

Yet Exxon has come running back to Putin for more. And its haste to win Rosneft's hand -- one of its hands anyway -- suggests it felt competitors breathing hotly down its neck. This says at a minimum that multinational business does not want to assign Russia the pariah status that some U.S. editorialists would like.

Oil-producing nations have had a good crisis all in all. The hope that a surge of alternative energy sources plus a nuclear revival would make fossil fuels obsolete a generation hence has faded considerably of late thanks to events in Washington, Fukushima, and elsewhere. With the future smelling of oil again, Russia looks like an important counterweight to the growing dominance of Arab providers, whose political future looks far more volatile and threatening. Putin and his people meanwhile seem to have accepted that they will need outside know-how and capital to tap the tough new sources they need to remain a top-tier energy power.

This mutual long-term incentive is strong enough to offset if not overcome Russia's bad bureaucratic habits and unfathomable back-room disputes. There will be more deals to drill in the Arctic, East Siberia, and other forbidding Russian locales, and some of them will produce gushers.
No positions in stocks mentioned.

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