What BP’s new Russia deal means for investors

BP’s new deal with Russian oil giant Rosneft could give the company access to ‘a new North Sea’. But it also means that the controversy around the oil major is unlikely to fade any time soon. John Stepek looks at what the deal means for anyone thinking of buying BP shares.

When BP appointed an American, Bob Dudley, as their new chief executive, some might have thought that having a top man with a US accent would smooth things over with the States.

They were wrong. Mr Dudley has just unveiled a huge deal with a Russian partner which already has ruffled feathers in Congress.

The good news for BP is that US politicians are no longer calling it "British Petroleum". The bad news is that its new nickname is "Bolshoi Petroleum"

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What's behind BP's deal with Russia?

The Kremlin is about to become the biggest shareholder in BP.

BP is set to do a $16bn share swap with Rosneft, Russia's biggest oil producer. Rosneft which is state-owned, hence the Kremlin connection will own 5% of BP. BP's stake in Rosneft will rise to near 11%.

So what's behind the deal? It's all about access to new reserves. BP is going to explore the Russian Arctic with Rosneft. This is a complicated, risky region. That's why Rosneft needs BP's expertise. The payoff could be huge the region has been described as a new North Sea, in terms of its potential.

The deal does make sense. BP is the best-connected big western oil company in Russia. And with further expansion in the US looking complicated right now, Russia is the most sensible place to go. Despite the hassles with its TNK-BP joint venture, overall the deal has been good for BP it accounts for around a quarter of the company's global production, and near enough 20% of its global reserves, according to the FT.

So what does it all mean for investors?

As the FT points out, "financially the impact is relatively small in the short term as there is no requirement for big capital expenditures". The only immediate downside, as one City commentator noted, is that the deal pretty much makes BP "bid-proof", so the death of any speculation on that front might knock the share price in the short term.

If you already own BP, I certainly wouldn't sell it now. But what if you don't already own it?

The big issue facing BP is political risk. Getting further into bed with Russia increases that risk. But as the FT's BeyondBRICs blog notes, "nobody understands the risk/reward balance for Russia better than Dudley". Dudley was previously head of TNK-BP and ended up fleeing Russia in 2008 during a dispute between BP and its Russian partners.

BP isn't a safe, boring, dividends forever' stock. The Gulf of Mexico disaster showed that. But then, even among the blue chips, no stock is safe'. Any one of our big pharma companies could end up with a dangerous drug scandal on their hands. Big tobacco stocks are labelled defensives, but see what happens when emerging markets catch up with the West on the legislation front. And as my colleague Merryn has pointed out, any of them could fall prey to heavily-indebted governments looking for easy, cash-rich targets to tax.

Event risk could scupper almost any company. And it's hard to think of a solid' stock in any sector that hasn't faced some sort of damaging story, or political interference, in its history. There's no way to predict this sort of event as an investor. You can do all the due diligence you want. But at some point you have to trust that a company knows its business, and has contingencies in place to deal with problems as and when they arise.

The only real defence against these sorts of risks is diversification. As James Ferguson noted at our most recent Roundtable meeting, BP demonstrates why even investors in big blue chips need to hold a number of such stocks, rather than sticking all their cash into just one.

On balance, it looks as though BP is going to survive the Deepwater Horizon disaster. And it looks as though the company is going to restore the dividend. And of course it offers exposure to the oil industry, which is going to remain a vital part of the global economy for many years to come.

Two alternatives for investors

If you want a big UK-listed oil play without the litigation threat hanging over it and more certainty over the dividend, you could opt for Shell (it's paying out around a 5% dividend) as long as you remember the same thing could happen to it tomorrow. But if you're happy with a spicier option, then BP's likely to have more upside from here.

Of course, if you're comfortable with the risks of investing in Russia, you could also look at buying in directly. It's definitely not for widows and orphans, but you can check out the tips from our recent Russia cover story here: Russia: a risky but profitablemarket for the brave, and from Russian fund expert Mathias Westman here (just scroll to the bottom for the section on Russia).

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.