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Streetwise Professor

January 16, 2011

The Gambler’s Fallacy

Filed under: Economics,Energy,Politics,Russia — The Professor @ 2:34 pm

The biggest news of the last couple of days is the announcement of the BP-Rosneft agreement.  Under the agreement, the firms exchange stakes, and will undertake a joint venture (theoretically) to produce oil in Russia’s Arctic.

The BP move smacks of desperation.  The company reminds me of a gambler who has lost several big hands in a row, and figures that his luck just has to change.  The most recent big loss, of course, was in the Gulf of Mexico.  But it has also suffered major losses in Russia.  These include the effective expropriation of the Kovytka gas project; Gazprom refused to provide transportation from the field, the company was at risk of losing its license which required it to produce (which it couldn’t do because it couldn’t transport and sell), so it ceded the stake to Gazprom.  The other big loss involved BP’s current CEO, Robert Dudley, who was run out of Russia–literally–in a battle between BP and its Russian partners for control over the TNK-BP joint venture.

And of course other western majors have had bad experiences in Russia.  Shell over Sakhalin II.  Exxon over Sakhalin I.  This is why despite the fact that there is oil in Russia, other majors are not rushing out to do deals there even though they, like BP, are intent on finding new reserves.  As an example, Chevron Conoco-Phillips just sold its stake in Lukoil.

But BP has had its successes in Russia.

Just kidding.

It would be one thing if BP had proven its ability to navigate Russia’s treacherous energy politics, but it hasn’t.  Indeed, it has been very clumsy.  It was outmaneuvered continually in the TNK-BP saga. Its attempts to rescue its Kovytka stake were tragicomic.  They approached Igor Sechin–former intelligence operative, deputy prime minister, chairman of Rosneft, thug, and head of a Rosneft-centered clan that was a mortal rival of the Gazprom-centered clan–for help in dealing with Gazprom.  This was about as bright as approaching the Tagliattas to intermediate with the Corleones.

In one sense, you have to cut the company some slack for its past experiences: they are not alone.  No supermajor has had anything but headaches–and worse.  All the advantages are with the Russian state.  They have many levers that they can pull.  Everything from environmental and licensing rules to taxes to guns.

But that means that it is hard to cut the company slack about its current decision.  How could it possibly think that this time it will be different?

The nature of the oil business makes this problem particularly acute, and the risks of opportunism are particularly acute in the BP-Rosneft JV.  Rosneft needs technology to exploit the offshore opportunities in the Arctic.  BP has the technology and expertise.  BP understands that its ability to utilize that expertise in other areas, most notably the US  Gulf, are doubtful at best as a result of the Horizon disaster.  So, in some sense, there is economic sense to the deal, in that each party has something the other wants and needs.

But deals have to be enforceable, and here the problem is one of asynchronous performance that creates extreme hazards in enforcing any deal.  BP has to commit its technology and expertise and capital at the front end.  It does so in the expectation that when the oil flows, it will profit accordingly.  But once it has sunk its capital and technology into the frozen Russian wastes–once it has incurred massive costs–its bargaining position vis a vis Rosneft and the Russian state declines dramatically.  The Russian state can then start playing its tricks to squeeze BP.

And it almost surely will.   It is really almost impossible to fathom how BP believes that it can avoid this problem.  Asynchronous performance is inherent in the proposed JV.  Russia has a demonstrated track record of acting opportunistically, especially in the energy sector.  Reputation has clearly not kept Russia from acting opportunistically in the past.  There are no legal protections to speak of: indeed, in Russia, the legal system is the sword of the state, rather than a shield for private capital.  This means that BP will run extreme legal and political risks in attempting to collect on its commitment of capital and technology.

When thinking about this deal, remember one of the sources of dispute between TNK and BP: the former –the Russian partners–wanted to invest more outside of Russia.  That’s pretty telling, if Russia is where the best oil prospects are–physically, anyways.

Maybe BP knows something that isn’t immediately apparent that has convinced it that this time it will be different.  But it almost never is.

Hope springs eternal.  But to me, the more appropriate aphorism is: fools rush in where angels fear to tread.

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28 Comments »

  1. im sorry professor but your entire post above is b.s. i’m not going to repeat myself, just see my comment to your earlier post.

    Comment by jennifer — January 16, 2011 @ 2:43 pm

  2. As an example, Chevron just sold its stake in Lukoil.

    Conoco-Phillips.

    Comment by Tim Newman — January 16, 2011 @ 3:20 pm

  3. I’m not too sure about this one. I agree to a point with SWP, that BP needs to do something big in order to maintain its reserves and recover from the Deepwater Horizon incident, and that its determination to proceed in Russia probably reflects that it doesn’t have too many alternatives. And I also doubt that any project will reach the construction phase, from what I keep hearing about Shtokman projects in Russia are a case of one step forward, two steps back.

    That said, Russia is so important in that it has such enormous reserves, is non-OPEC, and represents one of the most accessible large unexplored regions that the major oil companies are always going to be interested, regardless of anything. Even after the Sakhalin II debacle, Shell remained interested in future developments for the simple reasons that 1. they still make tonnes of money and 2. it’s still worth it. Exxon, Total, Shell, and BP are either engaged in or actively pursuing projects in Russia, and I doubt that this will ever change short of a civil war.

    That said, I don’t think this necessarily reflects well on Russia. Oil companies will go pretty much anywhere, and the fact that oil companies are interested doesn’t mean anyone else is. Take Nigeria for example, most people would be insane to invest there, but oil companies do because they are the only ones with the clout to make it pay. However, I think it any supermajor will be thinking very carefully before committing money to the construction phase of a project in Russia, and it will be interesting to see how these pan out and what guarantees and assurances will be required before they do. I don’t rate BP as a company, but they probably learned a bit from the TNK-BP debacle, and will be keen not to repeat their mistakes. I don’t rate Shell much either, and I expect they will blunder into the next project having forgotten all about Sakhalin II. I expect the Russians will be reluctant to pick a fight with Exxon and I’d be surprised to see any future projects with them, and I think they’d not want to upset Total too much because (I think) they can bring greater political clout to bear if need be (in other words, upset Total and you’ll find France voting against you in the UNSC! Maybe.)

    Anyway, we shall see. But it’s pretty easy to sign bits of paper, less easy to actually execute a projects. Certainly BPs ventures in Sakhalin came to nothing, so I’ll not get too excited about this latest news just yet.

    Comment by Tim Newman — January 16, 2011 @ 3:39 pm

  4. Did you read Hu Jintao’s comments? Will this “currency war” go anywhere. Looks like China has allowed offshore trading of Renminbi. But given the troubles with the Chinese economy, it is possible that this move could backfire…Perhaps this was what Big Ben wanted to force out of China. A free trading in Renminbi will result in trade imbalances being correctly priced in. Anyhow very interesting developments in the currency markets.

    Comment by Surya — January 16, 2011 @ 6:44 pm

  5. [...] The Gambler’s Fallacy – via Streetwise professor – The biggest news of the last couple of days is the announcement of the BP-Rosneft agreement. Under the agreement, the firms exchange stakes, and will undertake a joint venture (theoretically) to produce oil in Russia’s Arctic. [...]

    Pingback by Simoleon Sense » Blog Archive » Weekly Roundup 111: A Linkfest For The Smartest People On The Web — January 16, 2011 @ 9:01 pm

  6. [...] – BP, Rosneft and the gambler’s fallacy. [...]

    Pingback by FT Alphaville » Further reading — January 17, 2011 @ 2:12 am

  7. [...] commentators have likened this new deal as the last desperate throw of a gambler’s dice, which may well [...]

    Pingback by White Sun of the Desert » The BP-Rosneft Exploration Pact — January 17, 2011 @ 9:46 am

  8. SWP, in case you’re interested I’ve written a post on the BP-Rosneft pact containing my thoughts here.

    Comment by Tim Newman — January 17, 2011 @ 9:55 am

  9. SWP there are quite a few spelling mistakes in your post.

    Comment by Didier — January 17, 2011 @ 10:39 am

  10. [...] This post was mentioned on Twitter by Rehabable. Rehabable said: RT @LibertyLynx: 'The BP move smacks of desperation.' Econ Prof Pirrong takes on the BP-Rosneft (Russia) agreement… http://bit.ly/hhg32G [...]

    Pingback by Tweets that mention Streetwise Professor » The Gambler’s Fallacy -- Topsy.com — January 17, 2011 @ 1:22 pm

  11. After President Barry effectively kicked them out of the GOM as well as everywhere, where else were they supposed to go?

    Everything aside, I bet you the stock goes up from here!

    Comment by HR — January 17, 2011 @ 2:14 pm

  12. @ Didier–I caught “bP” and changed it. Also changed Chevron to CP–which was a brain cramp, not a spelling error. Didn’t see any others, nor did the spellcheck in wordpad. Tell me the specifics, and I’ll change them.

    @Tim. I am sympathetic to your views, and they are well argued both here and in Desert Sun. There is perhaps another gambling metaphor that describes your analysis. That is that BP is doubling down for lack of any alternative. I’d agree with that.

    I think that there are differences between Nigeria and Russia, although I’d defer to your on-the-ground expertise in that regard.

    I agree with your point that Russia’s physical resources are so tempting that many companies will be unable to pass on the temptation–especially if they feel their alternatives elsewhere are constrained. But that temptation is the essential element in any con: playing on a pigeon’s greed or desperation. To me, XOM’s aloofness speaks volumes. XOM is no fool, and they tread carefully.

    I concur with your conjecture that the Arctic endeavor may well not proceed to the construction phase. Indeed, I was thinking of mentioning something about the fact that the Total JV seems to be in suspended animation.

    But that is just another problematic aspect of the deal. Without the prospect of something real in the Arctic, BP gets a stake in Rosneft which gives it virtually no leverage over that company, and given Russian accounting and governance standards, is unlikely to give it a firm claim on a proportionate share of Rosneft’s cash flows. But Rosneft gets a stake in BP, and will be the biggest shareholder–which could create headaches down the road. Plus it creates issues with TNK-BP. The only way the deal makes sense is if the Arctic pans out, and the company is not effectively expropriated in whole or in part if it does. You focus on the former risk, I focus on the latter. Together, that seems to be betting on drawing an inside straight (to use another gambling metaphor).

    @HR (and also Tim, in your Desert Sun post): Agreed that the political risk in the US was a major factor in BP’s decision, and definitely not a credit to the US and this administration. I blogged about that a bit in June. (One post was titled They Fight the Law. Will the Law Win?

    @ Jennifer. Agreed that TNK-BP has been profitable, and that my statement that BP had had no success in Russia somewhat hyperbolic. That said, (a) a good chunk of those profits came before 2007-2008, (b) the real tensions between BP, its TNK partners, Gazprom, etc., really ramped up at that time. Post-2006 and pre-2006 are different worlds. Putin’s resource nationalism became much more aggressive, and that’s the relevant experience in evaluating the risks going forward. Moreover, the contracting hazards that BP faces in the Arctic are more acute than involved in the TNK-BP operation: they are more analogous to the Kovytka situation, which was a major disaster. Insofar as the article you link in your other comment is concerned, it is way too glib and seems calculated to win friends in high places. In particular, I found its dismissal of what happened to Dudley and with TNK-BP generally to be a gross mischaracterization of what transpired. That shot the credibility of the entire article for me. (I also think it’s worth mentioning that the genesis of the TNK-BP venture included some shocking shenanigans in the late-90s and early-2000s.)

    The ProfessorComment by The Professor — January 17, 2011 @ 7:53 pm

  13. “nobody understands the risk/reward balance for Russia better than Dudley”
    http://blogs.ft.com/beyond-brics/2011/01/16/bp-in-russia-hope-over-experience/

    Comment by a.russian — January 18, 2011 @ 2:39 am

  14. I read Russian discussion forums in Russian, my native language.

    1. 90% of Russians hate “pindosi”.
    Pindosi is the special name for Americans who generally are considered naive and stupid.

    2. Giving pindosi a chance to make profit in Russia is considered unpatriotic.
    Everyone understands that stupid pindosi will be taken for a ride.
    Nobody in Russia has any doubt that the BP-bird is already in the cage.

    Why Robert Dudley agreed to be taken for a ride is an interesting question.
    Obvously, Russians gave him an offer he could not refuse.

    $100 million in a secret account in a Swiss Bank?
    A private island on his name?
    Sex with a Russian beauty filmed on a HD media?
    All of the above?

    I’d not even start to dig in this sewer pool.
    I’d simply put this son of a bitch against the wall and shoot him in the back of his head.

    Some time ago I’ve predicted on this forum that by the time O’Bum is out of the office, Russia will be much stronger,
    and America will be much weaker.
    As we see, Putin is not wasting any opportunity, while the Bum is bending over and over and over.
    It’s time to get rid of Bum-in-chief.

    Comment by Michael Vilkin — January 18, 2011 @ 3:53 am

  15. “I’d simply put this son of a bitch against the wall and shoot him in the back of his head”

    u r so civilized

    Comment by jennifer — January 18, 2011 @ 9:20 am

  16. p.s. russophobes are a classy bunch

    Comment by jennifer — January 18, 2011 @ 9:21 am

  17. > I’d simply put this son of a bitch against the wall and shoot him in the back of his head.

    Dude, was this intended as an extra proof you are a bona fide Russian?

    Comment by Ivan — January 18, 2011 @ 12:18 pm

  18. Jennifer, I don’t need to be civilized with Russian whores.

    Comment by Michael Vilkin — January 18, 2011 @ 12:27 pm

  19. Google everyone on Russian Google for ” ?????? “.
    Articles can be translated with Google Translate.
    You will learn a lot of interesting stuff.

    Russia is a beaten up snake that pretends to be a dry root of a tree (???? ???????????? ???????), and waiting for her opportunity to strike.
    Russia is an enemy state, not any kind of a partner.

    America is too civilized to round up Russian agents like Jennifer.
    It’s time to round them up.

    Comment by Michael Vilkin — January 18, 2011 @ 12:35 pm

  20. Actually, Googling “Michael Vilkin” will be far more productive.

    You’ll find that he’s a sad anti-Semite, fascist Ukrainian eking out a living in CA by selling kefir grains.

    Comment by Sublime Oblivion — January 18, 2011 @ 12:46 pm

  21. If BP wants to make money in Russia, the only way is to sell certain assets at understandable prices.
    For example: You wanna technology? Here is the price.

    To share in profits is a very stupid idea for BP.
    Profits can be reduced by 101 things like transportation costs, insurance costs, environmental fees, etc.
    As their will be no profits, BP will find itself in deep shit up to the neck, …scuse my Russian expression.

    To sell a controlling stake to Russians and to give them the full control of BP is beyond stupid.

    This dude Dudely was bought by Russians.
    The only hope is that this ugly deal somehow will not be approved.
    If it goes through, it will mean that Putin is well on his way to defeat the stupid pendosi.
    Russian agents and whores on this forum will be well rewarded.

    Comment by Michael Vilkin — January 18, 2011 @ 12:52 pm

  22. Sub, and at what price I sell kefir grains?
    $1 for postage.

    And at what price you can buy them on e-Bay?
    $10? $20?

    Your mother was a bitch, and your father was alcoholic.

    Comment by Michael Vilkin — January 18, 2011 @ 12:57 pm

  23. BP prefers dealing with criminals as opposed to dealing with socialists.

    Comment by Bob — January 18, 2011 @ 8:04 pm

  24. I’m not a russophobe so I don’t qualify :)

    The ProfessorComment by The Professor — January 18, 2011 @ 9:04 pm

  25. Bob, it’s not that BP prefers dealing with criminals as opposed to dealing with socialists.
    It’s that Russians feel that the West is damn stupid, and are taking the advantage while advantage is available.
    One son of a bitch like Dudley is in effect selling BP’s assets to Russians pennies on a dollar.
    A straight transaction of selling technology to Russians would have been very much more understandable and very much less ugly.

    Comment by Michael Vilkin — January 18, 2011 @ 10:49 pm

  26. Just the one inaccuracy. BP has had its successes in Russia. Around quarter of its profits come from dividends from TNK-BP. As a company whose job is to make money for their shareholders that seems quite a good thing.

    Of course there is political risk in dealing in Russia, but BP simply can’t afford not to at the moment. Their reputation has been completely shot in America (their other big market) so this is a potentially massive deal for the firm.

    Plus, anyone who understands the Russian oil market knows that state players have a massive advantage. That is why AAR (the other half of TNK-BP) is getting worried. The reason Conoco pulled out is that they were with Lukoil, another non-state player. Better the devil (or Sechin) you know. Rosneft is also seeking international legitimacy following Yukos, so it has an incentive to play by the rules on this one. Their deal with Chevron in the Black Sea is going fine, so far.

    It’s a risk politically, but the potential rewards are big enough that its worth taking. If you want to continue the gambler analogy it’s like going all-in at poker to double up when you’re short stacked.

    Comment by Ed — January 19, 2011 @ 8:19 am

  27. Ed,
    maybe, you know how to play poker, but you have no clue about Russia.

    Putin is getting BP pennies on a dollar.
    Assets of Rosneft will be reduced in the future, and BP will have ownership of nothing.
    There are 101 ways to do that.

    Rosneft might cheat on taxes and get stripped of assets.
    Rosneft might commit environmental violations, real or imagined, and lose the license to drill and pump oil.
    BP will be left with ownership of nothing.
    But the controlling stake in BP will be in Putin’s hands regardless of what happens to Rosneft.

    Ed, did you go to school?
    Was it a public school?
    Or are you broadcasting from Moscow?

    Comment by Michael Vilkin — January 19, 2011 @ 3:29 pm

  28. [...] The Streetwise Professor also goes with the gambling theme – “The company reminds me of a gambler who has lost several big hands in a row, and figures that his luck just has to change.” [...]

    Pingback by Official Russia | Weekly Blog Roundup, Monday 17 January 2011 — January 20, 2011 @ 12:02 am

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