British Petroleum, London, (NYSE: BP) shareholders aren't happy with company executives--not after a proposed deal between the company and Russia’s state-owned Rosneft to open up some of the former Soviet Union’s richest oil fields for exploration collapsed this week. What’s behind the botched deal, and how will it impact BP’s bottom line? Here’s the skinny on the deal that never went down.

BP's strategy was to leverage its relationship with Rosneft to open up drilling operations in the Kara Sea, a big opportunity for oil exploration, industry analysts had said. The region reportedly holds about 100 billion barrels of oil and gas, experts say.

BP had until May 16 at midnight to negotiate a deal with Rosneft. The thorniest issue proved to be BP's "other" Russian partners, TNK-BP, which balked at the proposed merger between BP and Rosneft. BP's Russian partners had filed legal action almost immediately after the deal hit the newswires last January.

TNK-BP participants successfully argued in a Swedish court that the Rosneft deal violated the terms of their joint venture with BP. That led to a court ruling that allowed the Rosneft deal, but only if TNK-BP could participate. That proved to be a deal-breaker for Rosneft, and one that BP couldn't overcome by the May 16 deadline.

Not admitting defeat, and not backing off, BP announced on May 17 that it would immediately seek to reopen negotiations, and sought to immediately pacify its TNK-BP partners at the same time.

Here's a statement from BP on May 17:

BP and Alfa- Access- Renova (AAR) announced today that they would intensify their efforts to ensure TNK-BP’s continued success following the lapse of the BP-Rosneft share swap transaction (and the related Arctic exploration opportunity) originally announced on 14 January 2011.

In recent months, BP has conducted detailed negotiations with AAR and Rosneft to seek a reasonable and businesslike solution that would allow the agreements to proceed to the satisfaction of all parties. Such a solution has not been found at this time, although talks will continue.

BP and AAR each acknowledge the active engagement and support provided by Rosneft throughout the recent discussions. Both BP and AAR see significant advantages in continuing to deepen this dialogue and cooperation with Rosneft.

Bob Dudley, BP’s new chief executive, said in a statement: "BP remains committed to Russia, to working constructively with AAR in TNK-BP and to our existing good relationship with Rosneft. All parties have worked hard to reach an acceptable resolution, as we believe it could offer significant benefits to BP shareholders, to Rosneft, AAR and Russia.

"TNK-BP has been an excellent investment for all parties since 2003 and it is gratifying that both BP and AAR have agreed to look beyond the disagreements of the past few months and to fully focus on this important and successful business we have built together," he added. "At the same time, we look forward to continuing our work with Rosneft in our Sakhalin joint venture, running our new joint German refining business, and considering other future projects."

BP says that TNK-BP has provided "consistently high returns" to partnership shareholders, adding that production in Russia has been on the rise. In 2010, BP reports that TNK-BP hiked oil and gas production by 3.1%, and replaced 134% of its reserves. Q1 profits hit $2.4 billion, a whopping 91% rise from the same period in 2010.

But BP's Russian partners remain edgy, as the oil giant gradually eases Rosneft into its global energy strategy. On May 1, BP announced a refinery partnership with Rosneft in Germany. As part of that deal, BP and Rosneft now are co-owners (on a 50-50 basis) of the following German oil refinery assets:

  • Gelsenkirchen Refinery (100% ROG)
  • PCK Schwedt Refinery (37.5% ROG share)
  • Bayernoil Refinery (25% ROG share)
  • MiRO Refinery (24% ROG share)

BP notes that ROG was established in 1983 as a 50/50 JV between Veba Oel GmbH and PdVSA, and has continued to operate successfully since BP’s acquisition of Veba Oel GmbH in 2002. According to the company’s website, "The ROG joint venture is operated by BP, and is a major contributor to the manufacture and supply of transport fuels and base petrochemicals in Germany." BP owns more than "19% of German refining capacity and 5% of the ethylene production capacity in Northwest Europe," BP adds.

But if BP's Russian partners get their way, the oil company won't find the path as clear in Russia with Rosneft as it did in Germany. Any thoughts of eventually resurrecting the deal are likely a fool's errand. And that’s not going to make shareholders happy.

"This opportunity is probably not going to happen" for BP, Jane Coffey, a fund manager at Royal London Asset Management, told The New York Times on May 17. "It leaves them without a strategy and calls into question the focus of the management."

Not to beat a dead oil spill, but the inference to management "focus" refers to BP's massive oil spill in the Gulf of Mexico in the summer of 2010.

The Rosneft deal was supposed to be a big "page-turner" from that environmental--and public relations--disaster. New chief executive Dudley was reportedly counting on the Russian deal to represent a new, profitable frontier for BP, but the botched deal with Rosneft puts that strategy into question.

"Investors were pinning a lot on BP’s Russian relationships," Colin McLean, chief executive of SVM Asset Management Ltd. in Edinburgh, told Bloomberg on May 17. "It was assumed that BP had good high-level relationships in Russia and that’s under question right now."

Worse, it also puts BP back into the spotlight--but not in a flattering way.

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