Rosneft, Now the Biggest Oil Company in the World, Will Control Russia's Arctic

Rosneft, the Russian state-owned oil behemoth, just signed a deal to purchase TNK-BP, Russia’s third-largest oil producer, for $55 billion. The deal makes Rosneft the largest publicly-traded oil producer. It’s a boon for private enterprise, especially as under the terms of the deal BP actually grew its stake in Rosneft – something Russian President Vladimir Putin had expressed concern about.

But the deal raises an important question: Where is Rosneft going to get $55 billion? The firm needs to prove it has new reserves under control to help secure financing. And that may mean Rosneft is confident that it will finally be able to start drilling in the Russian Arctic shelf.

It’s incredibly difficult to drill in the Arctic, what with extreme weather, the annual freeze, and technological issues like developing better blowout prevention tech because it’s nigh impossible to clean up an oil spill that’s under ice. As such, offshore oil wells are more expensive than launching a rocket into space, and drilling platforms for the Arctic cost somewhere between $5 billion and $6 billion apiece. Of course, with an estimated 25-30 billion tons of recoverable reserves in the Russian Arctic – versus 359 billion total proven reserves in the world, including shale and oil sands – means Russia’s Arctic shelf could prove incredibly lucrative. But for a long time, Arctic drilling has mostly been relatively small-scale, because the costs are so incredibly high. I mean, the incredible technological costs of even extracting Arctic offshore oil aside, just take a second to look at where the Laptev Sea sits in relation to Moscow:

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Currently, potential operations are focused on the Kara Sea to the west, situated around what’s called the East-Prinovozemelsky field. In 2010, the Russian government awarded the contract to develop the three sectors marked at the E-P field to Rosneft. Initially, Rosneft made a deal with BP — the home office in Britain, not TNK-BP — to develop the fields, but that fell through. Last August, Rosneft announced it was partnering with ExxonMobil in the E-P field, with Putin mentioning that total investment in the region could total $500 billion. (ExxonMobil, for its part, suggested the number was mere tens of billions.) As part of the deal, ExxonMobil promised to hand some global assets to Rosneft.

Currently, Rosneft and Gazprom, another state-owned oil firm, are the only two companies legally allowed to drill in the Russian shelf. That’s an advantage that both obviously want to protect, and both have been writing letters directly to Putin to try to circumvent the Russian government’s natural resources arm, which isn’t exactly glowing with positive reviews for the two firms’ efforts. From Barentsnova:

The Minister on Natural Resources Dmitry Donskoy reported earlier that exploration practices of Gazprom and Rosneft were “highly inefficient”. For example, three licensed blocks of Rosneft in the Kara Sea has 23 “promising structures” yet according to the company’s license-bound obligations Rosneft is planning to drill only four exploration boreholes by 2020. “To say that Gazprom and Rosneft are not active on the shelf is nonsense,” responds the letter signed by Miller and Sechin. I’n 2012, total volume of investments will sum up to RUB 40 billion; by 2017 – to RUB 500 billion at least. Not to take into account other expenses related to drilling rigs, vessels and onshore infrastructure."

That’s not to say that other companies aren’t trying to get into the shelf: Lukoil, Russia’s second-largest oil producer and which isn’t partially owned by the government, has submitted plans to spend $2.7 billion on oil exploration in the far-east regions of the shelf, including the Laptev. It sets up an interesting showdown: Russia has an interest in developing any oil reserves it can because it’s a huge source of revenue. But opening up exploration to companies that don’t have a government stake means that a whole lot of politicians would be losing out on sweet oil cash.

So what’s going to happen? Well, Rosneft suddenly spending an insane amount of cash buying up a firm — and bringing BP back into its fold — suggests that Rosneft now knows it has a bunch of cash it can secure and spend. Where’s it coming from? According to a report from Finmarket, it’s more or less coming from Putin, who has allegedly put the kibosh on giving permits to non-state firms like Lukoil. Rosneft has already been handed 14 blocks of drilling areas in the Russian shelf without competition, and the Finmarket report claims that Rosneft will have the rights to 75 percent of Russia’s Arctic reserves by the end of this year.

If that proves to be the case, Rosneft could very likely become the richest public oil firm on Earth (at the moment, ExxonMobil still makes more money, even if Rosneft currently has more reserves). In the process, BP should see a huge boost too, as the TNK-BP deal allowed BP to buy up a 20 percent stake in Rosneft. It also means that Russia’s government, which ranked 143rd out of 183 countries in Transparency International 2011 corruption index, has just handed one of the most lucrative oil contracts left on Earth to a mostly-government owned agency, likely meaning billions of dollars spent in development projects fueled, and skimmed off, by cronyism.

Billions of dollars being spent developing Russia’s Arctic shelf for offshore drilling sounds like a massive environmental worry, and it is. The risks of drilling in the Arctic are extremely high, and there are thousands of miles of leaky pipelines to build across some of the world’s most pristine environments. If you thought Deepwater Horizon was bad, cleaning up a spill in the Arctic is unimaginably more difficult, and the idea that BP might help Rosneft with safety sounds positively laughable.

Of course, adding another 25 billion tons of petroleum into the world’s tank is enough to make anyone with a rudimentary knowledge of climate change want to cry. But here’s the upshot: While Rosneft, which has a whole lot of interested parties in government, isn’t likely to face much in the way of regulation, it also will face almost zero competition. And if recent history is any indication, massive development projects in Russia are tasked more with making politicians money than actually getting stuff done. Last year, President Dmitry Medvedev announced that a trillion rubles—thirty-three billion dollars—disappears annually on government contracts, or three percent of the country’s GDP. It’s a small comfort, to be sure, but there’s always the chance that Rosneft will just endlessly spin its wheels with no other firms to compete against.

Possibly delusional hopes aside, Rosneft’s $55 billion deal signals that something huge is in the company’s future, otherwise it’s doubtful it could afford to buy TNK-BP. Rosneft is clearly Putin’s favorite pick to develop the Arctic, which means an incredible outlay of cash for infrastructure development, something that Russia especially wants in its massive Siberian frontier. That also means that, as oil prices keep rising and drilling tech gets more and more advanced, it’s getting to the point where drilling in the Arctic is economically viable. An enormous offshore Arctic oil boom is coming, and it’s being led by a government-owned agency in one of the most corrupt countries on Earth.

Follow Derek Mead on Twitter: @derektmead.