London (Platts)--25Mar2011/710 am EDT/1110 GMT

The future of BP's major Arctic exploration deal with Russia's Rosneft remains very much in doubt after TNK-BP successfully blocked the deal late Thursday, raising questions as to how BP thought it would be able to push the deal through in the first place.

Shares in both BP and Rosneft fell early Friday after a Swedish arbitration court ruled in favor of AAR, BP's Russian partner in TNK-BP, which had protested the deal, saying it contravened TNK-BP's shareholder agreement.

BP and Rosneft in January announced a $16-billion share swap and joint exploration of three blocks in the Russian Arctic, but the deal was temporarily blocked by AAR on the grounds that any new upstream opportunity pursued by BP in Russia should first be offered to TNK-BP.

Analysts were not surprised the tribunal ruled in favor of AAR.

"In our view this ruling should have been expected, since the TNK-BP shareholder agreement clearly states that BP should pursue new ventures in Russia only through TNK-BP," Credit Suisse said in a note.

NEW TNK-BP SHAREHOLDER ROW

The ruling not only throws the Arctic exploration deal into question but also raises the likelihood of a new major shareholder dispute within TNK-BP, just two years after a previous row threatened to derail the company completely.

AAR late Thursday was unforgiving in its reaction to the ruling.

"AAR welcomes the decision of the arbitration tribunal, which we expect BP to honor fully and absolutely," said AAR CEO Stan Polovets.

"Willfully ignoring the provisions of the shareholder agreement was a serious misjudgment by BP that has severely damaged the relationship between the TNK-BP shareholders -- it has also harmed BP's reputation in Russia."

In 2008, AAR and BP were embroiled in a bitter row over the direction of the company, with AAR saying BP was trying to use TNK-BP as a Russian subsidiary by not allowing its international expansion.

The row was settled after BP agreed to allow an independent CEO to replace then chief Bob Dudley and to give AAR more representation in the company's management.

Now, AAR expects more concessions from BP and its CEO Dudley following the "serious misjudgment" over the Rosneft deal.

"We expect Bob Dudley to make every effort to rectify the situation and rebuild the trust that has been lost between BP, AAR and the management of TNK-BP," AAR said.

BP, at least on paper, said it would honor its shareholder agreement with AAR.

"BP intends to continue to honor the TNK-BP shareholders' agreement to which it is a party with AAR, and will respect the decision of the arbitrators," it said in a statement.

ARCTIC DEAL FATE BP, though, said it still wanted the Arctic exploration deal with Rosneft to go ahead.

"BP looks forward to finding a way to resolve its differences with its Russian partners to allow these important Russian Arctic developments to proceed in future," it said, stressing it had the "scale and experience" to use new technologies to develop frontiers like the Russian Arctic.

It said it was "disappointed that these agreements, which are important for Russia, for Rosneft and for BP, cannot for now go ahead in the form intended, due to legal challenge by AAR."

However, AAR said the ruling also stops the share swap. "The tribunal decision means that BP is prohibited from entering into any future share arrangement with Rosneft that has any kind of a strategic component," it said.

Rosneft was itself silent on the developments, with a company spokeswoman declining to comment.

However, the company has made two things clear in the past weeks about a possible blocking of its deal with BP.

First, it said it saw no role for TNK-BP in the Arctic deal, ruling out one of TNK-BP's suggestions for resolving the dispute; and secondly, that Rosneft would seek compensation from either or both of BP and TNK-BP if the agreement were canceled.

WHAT HAPPENS NOW?

Rosneft has also said if the deal with BP falls through, it would look for other partners, indicating there has been a lot of interest in the project.

Analysts say they believe Rosneft would not hesitate to invite new partners into the exploration deal, leaving BP and AAR to sort out their differences on their own.

"This leads us to conclude that international majors remain interested in Rosneft's assets, and the court ruling will only delay the project without changing investors' perception of it," Moscow-based Alfa Bank said in a note.

As for BP and AAR, analysts say this latest dispute could spell big trouble for TNK-BP.

"On the face of it this looks a messy situation and one where we think BP will do well to emerge with all of its investment in TNK-BP, reputation in Russia and Arctic oil deal intact," Citigroup said in a note.

Credit Suisse said it believes the dispute would accelerate a change of shareholder structure at TNK-BP, raising the possibility of a transaction such as a sale of AAR's stake in TNK-BP or a secondary public offering.

The only other option would be for BP to give AAR a cash settlement in exchange for the Russians allowing the Rosneft deal to go ahead.

"The next step should be for BP to give cash compensation to AAR in order to get a waiver," Credit Suisse said, adding that it believes a settlement would be unlikely to exceed $500 million.

GOVERNMENT PRESSURE

The final element in the complex situation is the fact that the Russian government, as the main shareholder in Rosneft, gave its backing to the deal.

Citigroup said the government could step in to put pressure on AAR shareholders to back down.

BP would have been aware of its shareholder agreement within TNK-BP before agreeing the Rosneft accord, so it is possible Dudley thought having the backing of the Kremlin would have been enough to push the deal through.

As it stands though, BP will have to satisfy itself with the fact that the share swap element of the deal could still go ahead.

It said it plans to apply clearance to proceed with the share swap part of the Rosneft deal on its own, while at the same time hoping it can resolve its differences with its Russian partners to allow the Russian Arctic development alliance to proceed.

--Stuart Elliott, stuart_elliott@platts.com

--Robert Perkins, robert_perkins@platts.com

--Jake Rudnitsky, jake_rudnitsky@platts.com

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