Outlook: Eastern reserves hold plenty of promise for oil investors

The definition of an emerging market, it is sometimes said, is a market from which it is impossible to emerge. Lord Browne of Madingley, chief executive of BP, is taking a big gamble by putting up $6.75bn (£4.2bn) in cash and shares to buy further into the former Soviet Union. He doesn't see it that way, of course, and nor does the stock market to judge by yesterday's very positive share price reaction to BP's latest mega-deal.

None the less, to think BP's got itself a bargain in securing a half share in what will become Russia's third largest oil company you've also got to believe that Russia has put its history of totalitarian instability and economic turmoil behind it. The last 100 years doesn't provide much encouragement, but BP has assessed the risks and reckons this one worth taking. Other oil companies, it insists, would give their eye teeth to be in the same position. President Vladimir Putin is unlikely to sanction foreign participation in any of Russia's other oil majors any time soon.

Russia is the world's biggest known source of untapped oil reserves outside the Middle East, and Lord Browne may have a point when he says that in the search for politically stable areas of supply, Russia compares pretty favourably, however dodgy you might think its economy.

On the once-bitten, twice-shy principle, BP should be running a mile. It got badly ripped off when it first bought into Sidanco. BT's experience was a salutary lesson in the perils of naive Western investment at the wild eastern frontiers of Russia's gangster economy.

The Russian debt crisis confirmed everyone's worst fears about the lawlessness of Russian capitalism. Much of the money lent by the IMF in an attempt to keep the Russian economy on the straight and narrow seemed to end up in the hands of the Russian mafia, from where it was recycled into the London housing boom among other no doubt worthy causes. Needless to say, the country ended up defaulting on its international debt obligations.

After such behaviour, the capital markets should have remained closed to Russian participation for a generation or more, but then came Vlad, a flat rate tax system, and, based on all that lovely oil, a Russian economic miracle. Lord Browne says BP has learned from its mistakes and in any case is putting in place a corporate governance structure that will protect it from past frauds. Unfortunately, nothing provides much protection against governments dead set on sequestration, and Lord Browne will just have to hope that Russia is now sufficiently integrated into the world economy that it would have a lot more to lose than to gain from a return to past oppression.

Other British companies have tended to steer clear of the latest Russian goldrush, with the notable exception of Scottish & Newcastle, which last year bought into one of Russia's leading brewers. But if Lord Browne is right, then they are making a big mistake. In his view Russia has nowhere else to go other than the integration route, and as a consequence it won't be burning international capital again.

By BP's own standards, Russian oil comes cheap ­ just a fraction of the value it would have to pay for a Western oil company. By Russian standards, on the other hand, BP is paying top dollar. The detail needn't concern us too much here, but if BP's own admittedly conservative estimate of oil reserves is correct, it is paying $3.10 a barrel of oil equivalent, against a value for Yukos, the second-largest Russian oil company, of $1.80, and just $0.9 0for Lukoil, the biggest. Perhaps as worrying, BP isn't getting control for its premium price. BP nearly always insists on management or stakeholder control as a pre-condition for involvement in any region. In this case it has been unable to secure it.

Even so, BP is still paying a lot less for its Russian oil than the same deal would cost in most places elsewhere, and assuming all goes to plan, Russia will quickly establish itself as BP's most important area of production and reserves. Depending on what definition of reserves is used, BP's 50 per cent stake in TNK/Sidanco could account for anything up to 15 per cent of BP's total.

Still smarting from his missed production targets ­ Lord Browne doesn't do missed targets ­ the BP chief executive was in no mood to disappoint yesterday, and in a presentation that was remarkable as much for its longevity as its substance, he bamboozled his audience of City analysts and journalists with a mind boggling array of forecasts, ratios and strategic planning projections. After a marathon three-hour session, even his fiercest critics would have been bludgeoned into submission. But it was also a supremely convincing performance ­ no, really.

Lord Browne and his team set out a compellingly detailed road map for BP's journey from a company that relies for the great bulk of its production on the North Sea, Alaska and North America to one that four years hence will derive 40 per cent of oil and gas output from the newly developed regions of the Gulf of Mexico, Trinidad, Angola, Azerbaijan and the Asia-Pacific. To these, now, must be added Russia. Nothing is certain but, by the look of it, Lord Browne is delivering on his promise of building a secure future for his company and its shareholders. Russia is a big risk, but in the context of capital spending that regularly surpasses $14bn a year, it is also an acceptable one.

Economics of war

Uncertainty is the chief enemy of stock markets, but are they going to bounce very much once the Iraqi issue is finally resolved? I know that this is conventional wisdom, but I've got my doubts. I'm not going to engage in the largely futile "what if" game of mapping out the likely impact on markets of differing scenarios, but I do regard the now open contempt with which America on the one hand and Germany and France on the other regard each other as a deeply worrying development, the after effects of which will linger for possibly years to come, whatever the outcome of the Iraqi crisis.

These divisions threaten to foster an atmosphere of introspection and isolationism which could prove highly damaging to an already fragile world economy. It is Lord Robertson's job as secretary general of Nato to say that the present crisis within the alliance is a temporary thing that will vanish as quickly as it blew up as soon as the uncertainty over Iraq goes away, but I don't believe it.

Two weeks ago I saw him at a conference similarly trying to paper over the early cracks in the alliance that had developed over Turkey's request for defensive deployment. These were just arguments about timing, said Lord Robertson, not about substance. His explanation was incredible then, and it is doubly so today. What is emerging is one of the most serious transatlantic rifts since the Second World War, and this is not a sound basis for robust economic recovery, We shouldn't entirely give up hope for a second UN resolution, but it is looking a lot less likely than it was and if the US goes to war without it, the consequences for international relations could be catastrophic. Tony Blair will not be the only member of the British government praying that the UN swings behind the US. So, too, must his supposed rival for the job of prime minister, Gordon Brown.

Already the Chancellor's growth targets for this year are coming apart at the seams, endangering ambitious plans for higher public spending. Last week's out-of-the-blue interest rate cut is powerfully indicative of just how precarious the economic situation has become. For the Iraqi crisis to drag on for another three months might tip the UK and US into recession. The economy and the stock market need a swift resolution.

And then after that? The aftermath of the technology bubble is proving extraordinarily difficult to exorcise from the system. Business confidence and investment is still rock bottom, as Alan Greenspan, the Fed chairman, pointed out yesterday, and with the world economy continuing to struggle with massive overcapacity, it's hard to see why it should come back anytime soon. A resolution of the Iraqi crisis may provide a short-term palliative. The problem is, it may be no more than that.

jeremy.warner@independent.co.uk