September 2, 2012
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№ 6 (June 2012)

BP and TNK – the Bickerson’s Head Towards Divorce

   “Nations have no permanent friends or allies, they only have permanent interests...” Lord Palmerston, (1784-1865).

And so it is with BP in Russia circa 2012.

 

By Commentary by Pat Davis Szymczak

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   BP’s divorce from TNK isn’t playing well for Russia’s image in the foreign media. Surprised? The press likes to call out business disputes in Russia like a football “play by play” in which Russia always gets the penalty flag. When shareholders in a private business argue and restructure their property interests, it is described in the business press as exactly that – if it is all western owners.
But given the same relationship in a private company in which Russians and westerners share ownership, somehow the dispute becomes an indictment against doing business in Russia. So is BP a victim here? Hardly!

   Over many years in Russia, BP has played a game of chess for long-term gain. And considering how serious Russia takes its chess, BP has done a good job of it. BP might “exit” TNK-BP but it is certainly, not about to “exit Russia” as some foreign press put it. BP’s tie-up with TNK is one of many liasons it has had in post-Soviet Russia and like the others, it has outlived its usefulness and it is time to move on (not out.) Neither partner is “bad”, it’s just time to get a divorce.

   The irony is that when all the dust settles, BP will have profited handsomely from its relationship with TNK. And as the two move separately (or with new partners) into the future, BP will be most likely aligned with Russia’s national companies and the Kremlin, which uses energy policy as a tool of foreign policy. Meanwhile, TNK will have the freedom to expand outside of Russia and become a global player.

   On the money side of things, consider what Chris Weafer, chief strategist at Troika Dialog, wrote earlier this month in The Moscow Times:
“BP’s return from its investment in TNK ranks it as one of the best deals in recent history. BP paid $7 billion for its 50 percent stake in TNK in 2003. Since then, it has received $19 billion in dividends and, according to reports, is in line to receive $25 billion or $30 billion for its 50 percent stake should it sell it in the near future. That comes out to a profit of about $40 billion, or a nearly 600 percent investment return over nine years.

   “Even though a lot of that profit was generated by the huge rise in oil prices, there are not many investments anywhere in the world that would have produced this huge return in the same time frame.”

   In Moscow, Weafer is no talking head. He is an expat Muscovite who has been around since the 1990s and he is respected by other expat Muscovites as one of the very few oil and gas analysts who really understands Russia.

   So what really has been BP’s business track record in Russia? The Oil&Gas Eurasia team did a little research, and I’ve peppered the results with my reminisces that go back to 1994 when I first landed in what was then Yeltsin’s Russia to work for the industry’s first (and then only) oil and gas trade publication – Russian Petroleum Investor – at a time when the first Soviet oil assets were under privatization.

   BP took its first serious steps in post Soviet Russia in 1997 when it paid $571 million for a 10 percent stake in Sidanco. BP’s objective at the time was to get Sidanco’s license to develop the Kovykta gas and condensate field in Iruktusk. TNK-BP recouped this investment in spring of 2011 when it sold the field to Gazprom for $770 million. Quoting analysts, the Financial Times reported than that markets expected Gazprom to pay far less, but the end result was win-win: TNK-BP got its money back while Gazprom secured the State’s monopoly on gas exports to China.

   Kovykta had been designated in Soviet times as the source of supply for Russian gas exports to China. Multiple pipeline routes were being discussed and the USSR invited in foreign specialists in the late 1980s, Amoco in particular, to help make those assessments. (Amoco, remember was later acquired by BP.) I recall talking to an Amoco executive in Moscow who had been at Kovykta in the 1980s. What he found so remarkable about the field was the reservoir pressure, which meant fewer compressors would need to be installed along the pipeline. Building to Beijing might actually be commercially viable.

   With the Kovykta license in hand, BP moved farther east to Sakhalin where it worked in 1998 with Rosneft to complete geological surveys of several blocks to the north of where ExxonMobil and Shell were working. today, BP still holds 49 percent in that venture in Sakhalin.

   TNK entered the picture in late 1999 when it staged a hostile takeover of Chernogorneft, Sidanco’s main production company. Peter Aven and Michael Fridman, owners of Alpha Group (one of the “A”s in AAR (Alpha-Access-Renova) which today constitutes the 50 percent Russian ownership of TNK-BP), admitted in the media at the time that that they wanted to strike out at fellow oligarch Vladimir Potanin since his Interros Group had beat out Alfa on three big deals including privatization of the state-owned telecoms holding company.

   TNK eventually bought Potanin out of Sidanco for $600 million and as part of the deal, BP was allowed to keep its 10 percent stake in Sidanco. TNK followed up with more hostile takeovers, including Canadian producer Yugraneft, a West Siberian independent owned by the Canadian holding Norex. During this time, Slavneft was also acquired.

   But it was during this turbulent period also that TNK laid the foundation on which it has built its reputation as a champion of western technology and management practice: in 1998, it recruited a Soviet born, U.S. citizen Semyon Kukes as President and CEO. While many Russian oil companies were being run by bankers and asset strippers (usually both), TNK’s Russian ownership put a Phd chemical engineer with academic credientals from the USSR Academy of Science and Rice University in Houston at the top of the management pyramid. His workplaces had included Amoco and at Phillips Petroluem.

   As Ben Aris, another respected Russia watcher and blogger wrote of Kukes in 2001: “… under a deal signed with the US Export-Import Bank, money was raised to hire Halliburton, to help manage TNK’s Samotlor field. This deposit was once one of the most productive oil deposits in all of Russia, but these days most of what the nodding donkeys are bringing up is water pumped down into the ground in Soviet times to maintain well pressure.”

   When local managers resisted Halliburton’s innovations, Kukes moved to Niznevartovsk to oversee things himself. He later recruited a whole tier of expat middle management whose job it was to also mentor young Russians to eventually replace the expats. TNK was unique in this regard among Russian oil companies. Others recruited foreigners for only executive suit positions, not engineering and other middle management where a real change in corporate culture could be affected.

   So while many foreign vendors see TNK-BP as a friendly face in Russia because of the “BP” in the name – that’s really not true. By 2003 when the 50-50 JV between the two was officially consummated, Kukes had already laid the groundwork for developing Russia’s most western-minded oil company; at the behest of the Russian owners. In 2003, Kukes left by the way, to become CEO of Yukos. He was replaced by Robert Dudley, a BP man, who served until 2008 when he was forced out after a dispute among Russian shareholders as to the value BP brought to the partnership.

   The Russian side had a point: The BP side resisted TNK-BP growth into international markets where the Russian JV might compete with BP. On the other hand, BP couldn’t do much in Russian on its own. Under its contract with its Russian partners it was to act through TNK-BP.

   As probably anyone who has read so far know – Dudley left Russia in 2008 claiming to have been harassed out of the country by the Russian owners. But after he took over as CEO of BP itself, he was welcomed back into Russia and in fact brokered the deal to remarry BP to Rosneft and explore the Russian Arctic.
If you want to talk about the “rule of law”, TNK-BP had every right to call foul and insist that BP honor its contract with TNK. So not surprisingly, divorce proceedings have begun. And the issue of this very sell-off was raised quite some time ago when BP said it would likely have to sell off some of its assets to pay damages assessed in the Macondo well spill in the Gulf of Mexico. ($25 billion as reported this week by Dow Jones.)

   And I wouldn’t be surprised if the story twists a turns even more, looking ahead. Remember Rosneft jumped into bed with ExxonMobil when BP had to drop out of its engagement with Rosneft in the Arctic? When it comes to investment capital and know-how, ExxonMobil is as worthy as BP to be Rosneft’s partner.

   But there’s one problem: the BP–Rosneft deal had included a $16 billion share swap that would require a level of due diligence on BP’s part. This legal due diligence would have closed any questions of illegality in Rosneft’s takeover of Yukos.

   ExxonMobil refused to participate in a share swap and the issue of how to book reserves remains a bit fuzzy. Keep in mind, that BP invested $ 1 billion in Rosneft's IPO. As I said earlier, it’s a chess game and there’s no check mate yet.

Timeline"

1997 BP buys 10% of SIDANKO shares
1998 The alliance between BP and Rosneft for Exploration in Sakhalin
1999 BP Amoco: the oil spill in Alaska
2000 The new BP-logo: “Helios”
2001 British Petroleum  ->  BP
2002 The alliance BP-Rosneft: the license for Kaygansko-Vasyukanski block’s exploration
BP bought blocking shareholding of SIDANKO
2003 TNK-BP is born: BP pools russian assets with AAR
2004 TNK-BP sets goal to be Russia's Oil&Gas leader
2005 An explosion at BP refinery at Texas city: the biggest penalty in business history ever - $87 millions
2006 The oil spill in Alaska: the Prudhoe Bay field is closed
2008 Robert Dudley’s resignation of TNK-BP office
2008 A conflict between TNK-BP shareholders
Decapitation at BP HQ:
John Brown -> Tony Hayword
The gas escape in Azerbaijan on Central Azer platform
2009 Michael Fridman is appointed CEO of TNK-BP
2010 Decapitation at BP HQ: Tony Hayword -> Robert Dudley
Deepwater Horizon oil spill in the Gulf of Mexico: 152 days of oil spillage, 5 millions barrels, 13 victims, 75 000 sq.km of oil spill, invaluable damage to ecology
2011 The collapse of Arctic deal of BP and Rosneft
2012 BP’s potential sale of its interest in TNK-BP

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