April 8th, 2011

BP-Rosneft Deal on Hold Indefinitely, Investors in Russia Told to Study Kremlinology

In London, an injunction prohibiting the share-swap agreement between BP and Rosneft was issued indefinitely. The group Alfa Access Renova (AAR) had an agreement with BP as their investment partner in Russia. BP, still reeling from the Gulf Oil disaster looked to the deal with Rosneft to expand their exploration into the Arctic Circle. BP’s shares have gained 2.6 percent so far this year but still trade well below their value of before the Gulf Oil Spill. The injunction is likely to give AAR more leverage, and money, from any resulting BP-Rosneft deal.

WSJ’s Heard on the Street urged potential investors in Russia to study Kremlinology, the study of the murky underbelly of the Russian government. When BP made the deal with Rosneft, it no doubt received strong support from the Russian government since Igor Sechin is both chairman of Rosneft, deputy prime minister and close confidante of Prime Minister Vladimir Putin. Despite these close ties, the Kremlin has not used its muscle to lean on AAR to forgo their legal battles against BP and Igor Sechin is about to lose his chairmanship at Rosneft.

Despite these and other efforts by President Dmitry Medvedev to make Russia more enticing to foreign investors, critical factors remain:

The country needs to attract more foreign direct investment: It fell 13% to $13.8 billion last year, half the level in 2007. Gross domestic product growth could fall to 2.5% to 3% per year in the next 10 years, compared with 6% to 7% in the last decade unless annual foreign direct investment is ramped up toward $75 billion, investment bank Uralsib forecasts. The government wants foreign investors to participate in a planned $35 billion of state-owned company flotations in the next three years. Industries from farming to oil and gas also need foreign expertise to develop.

…so long as former Yukos boss Mikhail Khodorkovsky languishes in jail, many will be sceptical Russia’s legal system is truly independent. Political risk is the reason Russian equities trade at 9.1 times expected 2011 earnings, a 20% discount to their emerging market peers. It would take a brave Kremlinologist to bet on that gap closing.

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