The Oil Lord

With a bold deal in Russia, BP's John Browne is once again changing the industry

With enough g-force to send a drink sloshing backward, BP PLC's Gulfstream 5 roars down the runway of Moscow's Vnukovo Airport and climbs rapidly into the clear night sky. Soon a steward appears, bearing champagne and caviar. The seven executives on the plane gather around BP Chief Executive John Browne and drink a toast to BP's new Russian venture. "Here's to Russia," says Browne. "A country that has come so far so fast that there is no going back."

Go far, go fast: The same could be said of BP's 55-year-old boss. During his two-day September trip to the Russian capital, Browne packed in as much as a visiting head of state. With police escorts parting the traffic for his motorcade, he delivered two lectures to university students, met with Russian Prime Minister Mikhail Kasyanov, jawed about strategy with his Rus- sian partners, and hosted a party for VIPs among the gold-and-silver-framed medieval icons of the Kremlin Armory.

Browne had good cause to celebrate. Just days before, on Aug. 29, BP (BP ) had finalized an $8.1 billion deal with Russian oil producer TNK, one of the energy giants created in the wake of the Soviet collapse. An $8 billion deal? In the oil patch, that's middling -- Browne's acquisition of Amoco Corp. alone was $62 billion. But size isn't why this deal is special. The successful end of two years of negotiations marked the first time a Western oil company had acquired a major equity stake in an integrated Russian oil outfit. BP, which vies with Royal Dutch/Shell Group (RD ) for the title of the world's second-largest oil company after Exxon Mobil Corp. (XOM ), now has a 50% share in a new venture dubbed TNK-BP, which already pumps 1.2 million barrels a day of crude from fields in Siberia and the Urals, and delivers $1.7 billion in cash flow. Browne is even more intrigued by TNK-BP's future prospects as an exporter to its neighbors in Asia and Europe. After all, the company may have resources on the order of 35 bbl. of oil equivalent -- nearly twice BP's current reserves. The remaining 50% belongs to a group of Russian partners led by Mikhail Fridman, chairman of the sprawling Alfa Group conglomerate and one of the country's most powerful oligarchs. "This is an opportunity with very long legs," says Browne.

Now others are scrambling to keep pace. Just weeks after Browne's triumphant visit to Moscow, market sources confirmed that Exxon was in negotiations with Russia's top producer, YukosSibneft Oil Co., to acquire a stake as large as 40% for upwards of $20 billion. YukosSibneft is also said to be in discussions with ChevronTexaco Corp. (CVX ). Meanwhile, there is talk that ConocoPhillips (COP ) is interested in Lukoil. The more the merrier, says Browne: "If it's good for the Russian oil industry, it's good" for BP.

It won't be the first time Browne has set off a deal avalanche. Just five years ago, BP's acquisition of Chicago-based Amoco forced the other giants to search for new partners. Exxon's $87 billion purchase of Mobil followed, as did Total's mergers with compatriot Elf and Belgium's PetroFina; and Chevron's takeover of Texaco. "I think the Russia deal is analogous to the Amoco merger," says Daniel Yergin, chairman of Massachusetts-based Cambridge Energy Research Associates. "[Browne] is a game-changer."


No question, Browne's timing is impeccable. The RTS index of Russian stocks is up 76% so far this year, and foreign direct investment is set to reach $5.5 billion, buoyed by big-ticket transactions like the BP deal. Rising prices for oil and other commodities, which make up the bulk of Russia's exports, along with steady improvements in the local business climate, are among the main draws. Moody's Investors Service's decision on Oct. 8 to raise the country's sovereign debt rating to investment grade will probably send billions in fresh capital Russia's way.

The biggest lure: Russia's oil and gas reserves, equivalent to 362 billion barrels of oil, are the largest of any country. With sources in the West drying up, the hunt for acreage is on. Major troves, such as those in Saudi Arabia, Kuwait, Mexico, and Venezuela, are still mostly the province of national oil companies. That leaves Russia, where the private sector controls much of the oil patch. At around 8 million bbl. daily, Russia's oil production is comparable to Saudi Arabia's but is growing at about 9% a year, while OPEC quotas keep a lid on Saudi output. And while the Saudis have kept Western oil majors at arm's length, Russian President Vladimir V. Putin is ready to embrace them. "By 2010, Russia will no longer be a regional supplier, but the world's largest exporter of hydrocarbons," predicts Edward L. Morse, an executive adviser at Hetco, a New York oil trading firm.

Despite its appeal, Russia is still a place where vendettas and intrigues incomprehensible to outsiders can make or break deals. Just look at Yukos: While Putin seems ready to bless a deal between it and Exxon, government investigators are badgering Yukos boss Mikhail B. Khodorkovsky with judicial probes.

No one knows the risks better than Browne. BP was one of the first oil majors to venture into Russia after the collapse of the Soviet Union. Starting in 1996, the company began building a network of BP-branded petrol stations. Then in 1997, Browne plunked down $480 million for a 10% stake in Sidanco, an oil company controlled by oligarch Vladimir O. Potanin but coveted by Fridman and his partners at TNK. Following Russia's 1998 financial meltdown, Fridman used bankruptcy proceedings to strip Sidanco of assets. After a long struggle, BP cut a deal with Fridman in 2000 whereby it regained the assets and agreed to up its stake in Sidanco to 25% and explore a merger with TNK. Strange as it may seem, Browne says the battle drew BP closer to Fridman -- who will serve as chairman of TNK-BP -- and his partners.

BP's boss admits Russia still has a long way to go. "The rule of law is not widespread; corruption is widespread," he says. Yet Browne argues that the dangers in Russia may not be as great as those in the Middle East or the corrupt, politically turbulent West African states of Angola and Nigeria, where BP's rivals Royal/Dutch Shell and ExxonMobil are placing huge bets. Browne is not afraid to take risks as long as the potential rewards are there: "Where everything is cut-and-dried there is no opportunity," he says.

The TNK deal is the culmination of a five-year shopping spree launched by Browne to turn BP from an also-ran into a top-three oil company. Net income will soar 37% this year, to $12 billion, on revenues of around $170 billion, according to analysts. Throughout, Browne has stood out in the industry as a cerebral manager, one who still shows the traces of the physics student he once was. The son of a British army officer -- who later joined BP -- Browne began in 1969 working on what was then an even bigger gamble by BP, its foray into Alaska. Fresh from the University of Cambridge, where he earned top honors, the 21-year-old signed on as a trainee and was dispatched to Anchorage. There he learned about drilling wells. His knowledge of computers -- a rarity in those days -- and his ease with numbers earned the notice of his bosses.

That financial acumen has stood Browne in good stead. In 1982, he hatched a scheme to sell quarter-point interests in BP's Forties field in the North Sea to other oil companies, giving them production against which to expense drilling costs, thus lowering their taxes. The gambit netted BP about $300 million, and enraged the British Treasury. In the mid-1980s, Browne was also a trailblazer among British corporate treasurers in using new financial instruments -- derivatives -- for the purpose of hedging oil prices and arbitraging foreign exchange. Former BP Chairman Robert Horton says Browne "arguably invented corporate banking as far as Britain was concerned." Browne also knows how to sell. In 1989, when BP was experiencing a cash crunch, Browne raised $1.3 billion by selling off assets that a BP executive now dubs "moose pasture," or unpromising acreage.

On becoming CEO in 1995, Browne had little choice but to play the mergers-and-acquisition card. BP was a middleweight player disparagingly known as a "two-pipe" company; it was almost completely dependent on rich but maturing fields in the North Sea and Alaska. To bulk up, Browne persuaded Mobil in 1996 to combine its European refining and marketing operations with BP'S. Soon, Browne began stalking other prey. BP's takeover of Amoco turned BP into a heavyweight in natural gas -- which is growing faster than oil as a fuel. Prices for natural gas have tripled since the 1998 deal. BP's monster liquefied natural-gas (LNG) facilities in Trinidad are well positioned to feed the U.S. market.

Browne hardly stopped to digest Amoco. A year later, he snapped up Los Angeles-based Atlantic Richfield Co. for $31.8 billion. But BP only received approval to complete the deal after a protracted battle with U.S. regulators, who forced BP to part with ARCO's Alaska operations. The word around BP now is that the ARCO deal was not so great. Browne, however, kept going. Buying Britain's Burmah Castrol plc delivered a premier lubricant brand; Germany's Veba Oel boasts the largest marketing network in Germany.


Competitors, who in the past didn't consider BP a threat, now take it more seriously. Shell and Exxon banded together to make sure BP was relegated to a subordinate position in Saudi plans to lease tracts of natural gas acreage. Those plans collapsed -- to Browne's relief -- last spring. Shell later inked a much smaller deal with Riyadh.

There's another downside to BP's higher profile. Investors are less tolerant. When BP admitted last year that production growth would be just 3% -- well short of the 5.5% annual target the company had set -- the stock fell more than 7% in a single day. While the hit to earnings was small, Chief Financial Officer Byron E. Grote acknowledges that BP's "reputation as a company for meeting its targets" has sustained lasting damage.

Browne now downplays this episode, saying BP was foolish to allow itself to become hostage to a single statistic. But the snafu, which revealed that managers in the field were providing headquarters with unrealistic forecasts, goaded him into a thorough review of the whole organization. One conclusion: Employees of the acquired companies feel like stepchildren. And BP could do far more to improve efficiency. While it beats Exxon in finding and development costs ($3.91 per barrel vs. $4.71), the British oil major still trails its American peer in basics such as cutting pipes, building platforms, and other activities that suck up a huge part of the $15 billion BP invests each year, says Richard L. Olver, BP's deputy CEO. Take a look at return on capital employed, a key industry benchmark. In 2002, BP made 12.8% on a pro forma basis (excluding goodwill from the ARCO deal), compared with Exxon's 15.7%, according to Deutsche Bank.

Detractors also say Browne is such an overpowering boss that BP will have trouble grooming a successor. Browne bristles at such criticism. As part of a reorganization, he has placed six up-and-comers in charge of major units such as exploration and production and refining and marketing. Browne puts each through a grueling quarterly review of where they stand in meeting demanding performance contracts they sign each year. He dazzles in these sessions, say insiders, which often turn into strategy tutorials. But he doesn't like to be disappointed. "Their asses are on the line to perform," says a regular attendee.


Browne is no tyrant. But BP's modern, glass-walled offices on St James's Square in London's West End do have the feel of a court. It is almost required for every young, promising executive to work for him for around 18 months as a "turtle," a kind of personal assistant who does everything from making sure his schedule runs smoothly to carrying his cigar case. In that position, an acolyte gets to observe the Browne style: tireless, leaving no stone unturned. When something is bugging him, such as the recent management overhaul, he bears down for weeks at a time until he has worked it out. Those who have watched Browne in action say his ability to cut through reams of figures both awes and terrifies bankers and accountants. Henry M. Paulson Jr., chairman and CEO of Goldman, Sachs & Co. on whose board Browne serves, says the BP chief "is able to operate at 100,000 feet about the ground, yet has the discipline to know the specifics cold."

One rival that clearly transfixes Brown is Exxon. While Browne has driven BP's stock up smartly over five years, its performance still lags Exxon's by a whisker. A reason for optimism is that BP is adding to its reserves much faster than either Shell or Exxon -- a trend that may allow BP to ramp up production by 1.1 million barrels, or 30%, by 2007. Last year, BP's reserve replacement rate was 206%, compared with Exxon's 120% and Shell's 50%, according to Deutsche Bank. In recent years, BP has staked its future on five new areas: Azerbaijan, Trinidad, Angola, Indonesia, and the deep water off the Gulf of Mexico, where BP is expanding the limits of seismic technology to find oil beneath forbidding salt domes. Russia adds a sixth card to BP's hand.

While gaining efficiencies, Browne still wants to preserve BP's willingness to make big bets that can deliver a big payoff. The Russia venture certainly fits that description. The newly formed TNK-BP will be the third-largest integrated oil company in Russia, with estimated net earnings of $1.8 billion in 2003. Yet Browne trod carefully before he chose to team up with Fridman. Compared with the two other oil barons -- Lukoil President Vagit Y. Alekperov and Yukos boss Khodorkovsky -- Fridman seemed the best fit. The others may control better assets, but they, in BP's view, wanted to remain CEOs and might have resisted BP's management changes. Fridman, who already manages banks and telecoms, was looking for outside help. BP is supplying 110 managers, including CEO Robert Dudley.

For his part, Fridman and TNK's other major shareholders, Viktor Vekselberg and Len Blavatnik, are counting on BP's technology and management to transform TNK-BP into a company valued by international, rather than Russian, standards. BP's involvement could also smooth the way for expansion into Eastern Europe and China. "It is not so easy for a company that is just Russian, because of political suspicions," says Fridman, an affable 39-year-old. Unlike Khodorkovsky, Fridman has managed to avoid confrontations with the Kremlin -- a political plus for BP.

Browne, meanwhile, thinks he has the vehicle he needs to open up Russia's energy wealth. TNK-BP has huge reserves of oil and gas in eastern Siberia, especially in the Kovytka field, that it hopes to develop for export to Japan and China. Browne says that he told Putin that Russia should "become a great provider of energy to the Far East, just as it has to Europe."

But the British company has its work cut out. TNK's oil fields are old Soviet acreage in western Siberia and the Urals. They are in fairly bad shape, with bad salt corrosion, leakage, and environmental problems. BP's carefully nurtured image as an environmentally sensitive company could well be tarnished by its involvement in Siberia. Browne says cleaning everything up "will take a considerable time -- up to 10 years." But the backward conditions are also an opportunity. BP can squeeze out more production by simple techniques such as upgrading old wells and repositioning pumps. Even without the benefit of BP's input, TNK's output has been growing fast.

Another issue is keeping both Russians and British working together. Browne knows how big oil companies can stumble in foreign places: In Moscow, he told a group of students that BP had developed many of the oil fields in the Middle East but had been kicked out of them because of the rise of nationalism and "very bad colonial behavior. That must never happen again."

How to prevent it? BP thinks that the structure of the TNK-BP arrangement -- the board and senior management are evenly split between Russians and BP execs -- will compel both sides to work for their mutual benefit. The Russians, who have now received $2.6 billion, will be paid the rest over three years in BP shares and will be required to maintain their stakes in TNK-BP for the same period. BP's mantra is that interests are "aligned."

Browne has so far received little credit for his Russia foray in the financial community, which worries that BP paid a stiff price without gaining control. "BP clearly has the lead in domestic Russian oil," says J.J. Traynor of Deutsche Bank, in a recent report. But the Russians "are the financial winners."

Browne, who takes a longer view, likes what he heard about the new company on his trip. Production, after all, is rising 12% a year. Risks? Of course. But to the celebrants on that plane, Russia, stretched out below in the darkness, seems like a place of infinite possibility.

By Stanley Reed

With Jason Bush in Moscow

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