State group Rosneft tightened its grip on Russia's oil industry on Monday, announcing a $55 billion deal to buy domestic producer TNK-BP and make Britain's BP a one-fifth Rosneft shareholder with two seats on the board.

Rosneft, already the top oil company in the world's biggest producing country, will be pumping more oil and gas than Exxon Mobil with TNK-BP on board. With BP as a partner, powerful chief executive Igor Sechin can also pursue his dream of rivalling the industry number one on the world stage.

The deal gives Rosneft extra output and cash flow to finance exploration of Russia's vast reserves to replace ageing and depleting fields. It keeps BP's expertise in Russia and provides the "quality" private shareholder President Vladimir Putin wants in order to show his critics he is pursuing privatisation.

Part one of the Kremlin-backed deal folds BP's half of TNK-BP, Russia's third-largest oil firm, into Rosneft. In exchange, BP gets $12.3 billion of cash and 18.5 percent of Rosneft, raising its holding to 19.75 percent.

In stage two, BP's 50-50 partner in the TNK-BP venture, AAR, would get $28 billion, but the two deals are independent of each other and both are still subject to negotiations, Rosneft said.

The deal leaves the businessmen behind AAR with weakened negotiating power and Rosneft firmly in the driving seat, analysts said.

"This is a very good signal for the Russian market. It is a good, large deal. I would like to thank you for this work," Putin told Sechin at a meeting on Monday.

BP benefits by being able to exit a stormy relationship with AAR, and becomes able to pursue closer ties with a Kremlin that exerts a much tighter hold on the oil industry than it did in the 1990s when BP first invested in Russia.

"It's certainly a historic deal and a historic day for BP and Rosneft and TNK-BP," said Santander analyst Jason Kenney.

"I do think Rosneft is the winner in this. They get a lot of credibility by having a western investor on the board and involved in its Russian resource and operations, and it's a good partner to have."

FRICTION

TNK-BP is highly profitable and provides a quarter of BP's total production, but its fields are mature, and the Soviet-born tycoons who own the other half through AAR have blocked BP's search for growth in Russia through closer ties with Rosneft.

Executives at TNK-BP have in the past had run-ins with Russian law enforcement at times of friction between the shareholders, with two managers arrested in 2008 amid a dispute over strategy that forced then-CEO Bob Dudley, who now heads BP, to flee Russia.

Should the deal survive a months-long approval process, BP's exposure to Russia would be lower, but with seats on the board it has closer ties than any of its rivals to Sechin, who has a significant say in energy policy.

BP missed out last year on a deal to go into the Russian Arctic as a result of its feud with the AAR tycoons. It watched as Exxon, ENI and Statoil did deals there.

The cash also gives BP more headroom to give something back to shareholders who have suffered with a lack of capital growth as a result of its Russian worries, although analysts have said this may have to wait until BP's other headache, U.S. Gulf oil spill litigation, is settled.

"They're taking over $12 billion of cash back onto the balance sheet, that'll reduce their gearing from mid-20s down to mid-teens so it transforms the balance sheet," said Investec analyst Stuart Joyner "and the potential in the Arctic that they will access through Rosneft is quite high as well."

Dudley, under severe pressure from shareholders to show some progress after a difficult few years for his company, told BP staff in a note that "This is an important day for BP".

He stressed that the deal remains subject to more detailed agreements being signed as well as to government and regulatory approvals.

"We are making good progress towards these agreements, with a reasonable expectation that they will be concluded sometime during the first half of 2013," he said.

BP shares climbed four percent during last week as preliminary details of the deal emerged. On Monday they were down 1.25 percent at 444.8 pence, slightly underperforming the broader market.

The four tycoons of AAR, Mikhail Fridman, German Khan, Viktor Vekselberg and Len Blavatnik, are reluctant to remain in a joint venture with the powerful Russian state oil company.

Khan, who is effectively serving as chief executive of TNK-BP after the departure of other senior executives, told TNK-BP management on Friday that AAR had no deal to sell, and Monday's statement made clear there was no certainty it will happen.

VALUE TO BP?

Adding the $12.3 billion cash to the stock based on the price BP is paying for a portion of it, BP is getting a package worth $27 billion including an 18.5 percent stake to add to its existing 1.25 percent holding.

However, BP is paying a premium for the stock on Rosneft's share price, so the value could be calculated lower, at nearer to $25 billion, and lower still when taking into consideration the supportive impact of recent share buybacks by Rosneft.

Either way, although seen as positive by analysts, BP loses a dividend stream that has been providing it with about $4 billion a year.

Based on its new shareholding in Rosneft and that company's 25 percent dividend payout, BP would have only received around half a billion dollars last year.

Some observers are hopeful that this may change.

"BP's influence may improve corporate governance standards at the firm and ultimately reduce the corporate governance discount when it comes to the stock market valuation of the company," said Dr Andrey Golubov, a finance lecturer at Cass Business School.

BP's presence may also mean that the combined firm will have to start paying out more in dividends - again a positive development for minority shareholders."

Neil Shah, global head of research at Edison Investment Research, called the deal "game changing" for BP.

"BP will be left with a well of cash which should create a buffer for the costs from Deepwater Horizon (oil spill rig) and possibly fund future acquisitions," he said.

"We would like to see BP move from retrenchment to expansion, it would demonstrate confidence is returning, it is an oil super-major but only about the fifth biggest in the world and consolidation in the oil sector is far from over."