The Wall Street Journal-20080115-breakingviews-com - Financial Insight- Exxon Knows When to Fold- Lone Holdout Gives Approval To Save Deal With Kazakhs Over Kashagan Oil Field

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breakingviews.com / Financial Insight: Exxon Knows When to Fold; Lone Holdout Gives Approval To Save Deal With Kazakhs Over Kashagan Oil Field

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Exxon Mobil finally blinked in its showdown with Kazakhstan over the Kashagan oil field. Exxon was the last of the deal's partners to accept the less-advantageous contract terms acceded to by Italy's Eni -- the project's leader -- under Kazakhstan government pressure. Exxon recognizes that it can no longer afford to simply walk away from deals. So it may face more compromises to come.

Exxon isn't known for being easily bullied. Last year, it said adios to Venezuela after Hugo Chavez tried to strong-arm it into renegotiating its contracts. Earlier, it walked away from a deal to develop natural-gas wells in Saudi Arabia after disagreeing over terms.

But with choice projects becoming rare, Exxon Chief Executive Rex Tillerson has had to rethink his company's Texas-tough negotiating tactics.

And Kazakhstan was one of its biggest challenges. Last summer, the government tore up the contract it signed with Eni, Exxon and other oil companies in 1997 to develop its 13 billion barrel Kashagan oil field.

By the fall, Eni had negotiated a new deal giving the Kazakhstan government a bigger stake and some cash up front.

Eni couldn't afford to lose this project, as it is by far the largest one in its portfolio. Royal Dutch Shell, another partner, also needed the reserves. But Exxon balked, putting the project in jeopardy.

In the end, Exxon didn't want to be left out of one of the few remaining known major oil-field developments. The project was two years behind schedule and was costing Exxon millions of dollars in forgone revenue.

The Irving, Texas, company may worry that giving in to Kazakhstan will embolden other countries.

In reality, in a world where only 6% of known oil reserves are available for private-sector companies to exploit, government- controlled oil companies hold most of the cards.

The Cost of Double-Dipping

Talk is that Citigroup could report fresh 11-digit write-downs today. Merrill Lynch is in a similar, if smaller, boat. Both financial companies also are lining up new injections of cash. This is the second round of capital raising for both, and their first-round investors could come looking for better terms.

Citigroup, for instance, may have to adjust the $7.5 billion deal it struck in November with the Abu Dhabi Investment Authority. The investment authority, known as ADIA, bought debt that pays an 11% coupon before converting, several years hence, into stock according to a formula that results in ADIA giving up the first 17% of any share price upside.

If Citigroup issues more than $5 billion of equity or convertible instruments based on a stock price lower than the $31.83 a share that underpinned ADIA's deal, or paying a higher coupon, it has to improve the deal, according to published terms.

With Citigroup's stock trading below that threshold, one of those conditions probably would be triggered in any new investment. Citigroup wouldn't have to give cash back to ADIA, but it would have to hand over a bigger chunk of any price upside when the investment converts into shares.

By contrast, Merrill would have to hand over cash -- or the equivalent in extra stock -- if it issued shares at a price lower than the $48 set for the $4.4 billion deal it announced Dec. 24 with Singapore's Temasek Holdings. That is less likely to happen, since Merrill's stock has recovered roughly to where it was then -- enabling it to offer new investors a discount similar to Temasek's without breaching the $48 level.

Still, all this double-dipping could get expensive. If a company kept on going back for more capital and got steadily worse terms, it would affect investments from previous rounds and its cost of capital would quickly ratchet higher. Moreover, it would create a spiral of dilution for regular shareholders. They should be hoping Citigroup and Merrill raise enough new capital this time around to avoid going back again.

-- Cyrus Sanati and Richard Beales

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This column is by breakingviews.com, an online financial commentary site.

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