Exxon got stuck in the middle as Russia-US relations broke down — and needs a solution soon

Exxon Mobil‘s landmark deal to explore for oil in Russia’s Arctic and a portion of the Black Sea, and to drill for oil in Siberia, has run into a brick wall.

The agreement with Russian state oil company PAO Rosneft was signed in 2012 by current Secretary of State Rex Tillerson when he was still CEO of Exxon.

The deal was a strategic win for both companies: Rosneft lacks the technological ability to drill in cold offshore conditions by itself, while Russia became Exxon’s second-biggest exploration area.

However, the Obama administration leveled sanctions on Russia over its actions in Ukraine in 2014, which made it difficult for Exxon to hold up its end of the agreement.

Diplomatic relations between the United States and Russia have deteriorated further over the years after Russia intervened militarily in Syria and the US accused Russia of meddling in the 2016 elections. And although President Donald Trump advocated improving relations with Russia during his campaign, prospects of a thaw have somewhat faded following the US strike on Syria in April and the launching of an investigation into whether there were ties between Trump aids and Russia by Congress.

The clock might now be ticking for Exxon, although the timing is somewhat unclear. The Wall Street Journal reported that “under the terms of its deal with Rosneft, Exxon needs an oil discovery in the Black Sea by the end of this year to obtain a Russian government licence to drill” and that its exploration rights in the Black Sea “will” expire if the firm doesn’t act. The New York Times, meanwhile, reported that Exxon “could lose its exploration rights in the Black Sea if it did not begin drilling operations by the end of 2017.”

In response to queries about the timing of the contract, a representative from Exxon sent Business Insider the statement the company issued about the licence application and did not provide additional details:

“Our 2015 application for a licence under the provisions outlined in the U.S. sanctions was made to enable our company to meet its contractual obligations under a joint venture agreement in Russia, where competitor companies are authorised to undertake such work under European sanctions.”

And on top of that, the US oil multinational is concerned about its Italian rival’s ventures with Rosneft in the region.

A White House official recently told Business Insider that the administration would not lift or alter the existing sanctions until Moscow “fully honours its commitments to resolve the crisis in Ukraine.”

But, the Trump administration reportedly looked into lifting sanctions when the president — who is set to meet Russian President Vladimir Putin this week — stepped into office.

We took a look at how the dynamic for Exxon and Rosneft has changed before and after the implementation of sanctions.

The deal itself

The Rosneft-Exxon deal was signed in 2012 under the leadership of Tillerson. The joint venture expanded access to Russia’s offshore fields for Exxon, and opened the door to technology developed by US shale for Rosneft.

Energy exports are the backbone and muscle of the Russian economy, and Moscow reportedly had long been keen to develop some of its nonporous fields, which are difficult to tap with traditional drilling techniques.

The Exxon-Rosneft deal was negotiated after the United States under the Obama administration and Russia decided to pursue a “reset” in their relationship starting in 2009.

Exxon and other global oil companies had been eyeing Russia for years. An effort by the British multinational oil and gas company, BP, to sign a similar partnership with Rosneft failed a year earlier, and a decade before that Exxon was interested in buying a part of (now defunct) Russian oil behemoth Yukos.

But then, sanctions

The Obama administration issued an executive order in 2014 imposing sanctions on Russia in response to its actions in Ukraine. Sanctions were first leveled after Russia’s annexation of Crimea in March; they were then tightened after the shooting down of Malaysia Airlines Flight 17 over eastern Ukraine in July.

The red area is where Rosneft said it found oil. Wikimedia

Currently, sanctions on Russia include the prohibition of technology transfers for Russian energy projects in the Arctic, Siberia, and the Black Sea. They also prohibit dealings with Rosneft CEO Igor Sechin.

A key casualty of the sanctions ended up being the Kara Sea inside the Arctic Circle. Back in September 2014, Rosneft found oil in the Universitetskaya structure and reported that the area could hold an estimated 87 billion barrels of oil.

But Exxon and Rosneft couldn’t continue joint exploration of the area.

Fast forward to the 2016 election

Throughout the campaign season, Trump advocated improving relations with Russia. After his election, analysts argued there was a possibility that the sanctions imposed on Russia over Ukraine could be lifted, which theoretically would have major implications for energy.

However, the prospects of improving relations between Russia and the US somewhat faded several months after his inauguration following the US strike on Syria and the launching of an investigation into whether there were ties between Trump aids and Russia by Congress.

Another notable angle was Trump’s pick for secretary of state, Rex Tillerson, who was CEO of Exxon and has a close relationship with Russia and Vladimir Putin. There was immediate speculation that in his new position, he could push for sanctions on Russia to be lifted.

The secretary of state, however, said he is recusing himself from matters related to Exxon for two years.

Putin sechin tillerson rosneft exxon
Russia’s President Vladimir Putin (2nd R), Rosneft Chief Executive Igor Sechin (L, front) and Exxon Mobil Chief Executive Rex Tillerson take part in a signing ceremony at a Rosneft refinery in the Black Sea town of Tuapse in southern Russia June 15, 2012. Mikhail Klimentyev/RIA Novosti/Pool via Reuters

“I never lobbied against the sanctions. To my knowledge, Exxon Mobil never lobbied against the sanctions,” Tillerson testified in his confirmation hearing.

“Exxon Mobil participated in understanding how the sanctions were going to be constructed. And was asked and provided information regarding how those might impact American business interest.”

Waiver gets denied

Exxon applied to the Treasury Department for a waiver in 2015, arguing that competitors are less restricted and that it could lose exploration rights in the Black Sea if it didn’t begin working with Rosneft in the region by the end of 2017 under the terms of its contract with the Russian state oil company, according to reports.

The waiver request was first reported by the Wall Street Journal in April 2017, although at the time of publication, it was unclear whether Exxon applied before or after Trump’s election win.

Days after the report from the WSJ, the Treasury Department made a decision “in consultation with Donald J. Trump” that it wouldn’t be issuing waivers to US companies — including Exxon — authorizing drilling currently prohibited by sanctions.

Exxon released the following statement, noting that they “understand” the decision by the government, but warning that this presents an advantage to their European competitors:

“We understand the statement today by Secretary Mnuchin in consolation with President Trump. Our 2015 application for a licence under the provisions outlined in the US sanctions was made to enable our company to meet its contractual obligations under a joint venture agreement in Russia, where competitor companies are authorised to undertake such work under European sanctions.”

If the Treasury Department had granted Exxon the waiver, the timing would probably have been highly scrutinised given, first, Tillerson’s prior association with the firm and, second, the on-going investigation into whether there were ties between Trump aids and Russia.

Notably, Bloomberg reported, citing filings with the SEC, that Exxon previously received three waivers “to conduct unspecified paperwork” for its venture with Rosneft. They were approved twice in 2015 and in October 2016, with the first coming months after the sanctions leveled hit the project in the Kara Sea.

Who are the European competitors?

Exxon has argued for some time that sanctions put it at a disadvantage against some of its European competitors in Russia.

The EU version of sanctions on Russia is slightly different from the US’ in that there’s a grandfather clause for existing projects, which has allowed Italian oil multinational Eni SpA to continue its venture in the Russian sector of the Black Sea (while Exxon had to pull out.)

“Exxon is worried it could get boxed out of the Black Sea by the Italians,” a person who was briefed on the firm’s waiver application told the WSJ back in April.

A “source familiar with the situation who spoke on the condition of anonymity because he was not permitted to speak for his company” told the Washington Post in April it’s expected that Eni’s Maria 1 well will be drilled before the end of the year.

Eni and Rosneft signed an extension cooperation agreement in areas of upstream, refining, marketing, and trading in May 2017.

“The meeting consolidated previous agreements for the joint development of exploration activities in the Russian Barents Sea and Black Sea, and will underpin further opportunities between the two Groups, including the Zohr project,” the press release published by Eni said.

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