BP's Russian Joint Venture Falters

BP's profitable joint venture, TNK-BP is crumbling over a wrangle with its Russian partners about reinvesting dividends

In the fall of 2003, BP's (BP) then-chief executive officer, John Browne, flew to Moscow to kick off a groundbreaking Russian joint venture called TNK-BP. Browne was thrilled with the deal, which gave the British oil giant a position in a key country, but he was well aware of the risks. Russia, Browne said aboard BP's wood-paneled Gulfstream 5, is sure to be a big player in energy. "The question is whether you can work there," he said.

Five years later, Browne's successor, Tony Hayward, is discovering that the answer might just be no. Hayward is locked in a dispute with BP's Russian billionaire partners, a group called Alfa, Access/Renova, or AAR. The fight has driven TNK-BP's CEO, Robert Dudley, out of the country and has cast doubt over BP's once-golden future in Russia. "We're committed to finding a solution that's acceptable to all parties," Hayward says. "Whether that's possible," he adds, "we'll see."

Knowing the difficulties of Russia—and the bare-knuckled operators he picked as partners—Browne crafted a deal he hoped would stand the test of time. He struck a 50-50 joint venture agreement with the Russians, who had bought oil fields during the freewheeling privatizations of the 1990s. Both sides gained equal representation on TNK-BP's board. The Russians got to nominate the chairman, and chose MikhailFridman, AAR's leader. BP nominated Dudley, an American and a longtime protege of Browne, to be CEO. The company was incorporated in the British Virgin Islands, and disputes were to be settled by arbitration in Stockholm—something both sides are now considering.

VICTIMS OF SUCCESS

The deal was inked in June 2003, in a gala ceremony at 10 Downing St. in London, with Russian President Vladimir Putin and British Prime Minister Tony Blair looking on. Marrying BP's know-how to Russian resources has been a big success. TNK-BP's production has grown faster than any other Russian player's, and its 1.6 million-barrel daily output makes it the country's third-largest oil company. On July 29, BP reported that its share of TNK-BP's net income for the first half of 2008 was $2.1 billion, almost triple what it was for the same period in 2007. Over the years, BP and AAR have each gotten dividends totaling $10.2 billion from the venture.

Those fat payouts haven't kept the relationship from going rancid. At a board meeting in November, the two sides found themselves far apart on the dividends. Dudley argued that with production flattening and profits flagging because of steep Russian taxes, it made more sense to slash dividends and plow earnings into new fields and equipment, while the Russians wanted to keep the cash flowing. "Any CEO who comes to the board with a plan like that should immediately submit his resignation," says Stan Polovets, CEO of AAR. Eventually, the two sides agreed to go ahead with a capital expenditure of $4.4 billion for 2008 and to pay out $1.2 billion in dividends to each group in the first quarter, a TNK-BP spokesperson says.

But this spring, the spat got nasty. AAR called for Dudley's dismissal and demanded changes in governance, including an independent CEO. On July 15, Polovets wrote to Dudley saying AAR now opposes capital spending of more than $3.5 billion this year and threatening to hold the CEO personally responsible for anything the company spent over that amount. For his part, BP chief Hayward says the Russian shareholders want "to tear up the agreement that they willingly signed."

For the past few months, BP has been slapped around by various state agencies. In March, Russia's secret service, the FSB, swooped in on a Moscow cafe and arrested a Russian-American working for TNK-BP, charging him with industrial espionage. In April, Tetlis, a company founded by former employees of Fridman's Alfa Bank, filed a lawsuit in the Siberian city of Tyumen against TNK-BP, alleging it had improperly hired technical experts from BP. Tetlis won the first round, but BP plans to appeal.

The main whipping boy has been Dudley. In recent months he has spent much of his time dealing with a host of annoying issues such as tax complaints and labor grievances. Then in early July he was served with a lawsuit in which 16 TNK-BP executives accused him of discriminating against Russian employees. At a press conference, an exasperated Dudley blamed the actions on AAR and warned they would "tear apart the successful company we have built." The partners deny they have anything to do with the legal claims or regulatory measures.

The episode that led to Dudley's departure can be traced to Viktor Vekselberg, chairman of TNK-BP's management committee. Vekselberg argues that Dudley's employment contract expired in December, putting the CEO in technical breach of visa requirements. Although BP says the contract remains valid, the immigration authorities sided with Vekselberg. On July 24 Dudley left Russia.

The atmosphere inside TNK-BP headquarters, at the foot of Moscow's Arbat pedestrian mall, is poisonous. Until Dudley left, he was forced to work cheek-by-jowl with his rivals. He shared eighth-floor offices with Vekselberg and German Khan, the billionaire BP largely blames for orchestrating the regulatory moves. BP-affiliated employees, meanwhile, assume that their telephones, computers, and offices are bugged. Some switch mobile phone numbers weekly. Others write e-mails in code.

For months, BP boss Hayward kept relatively quiet about the dispute, but now he seems ready to take the gloves off. On June 30, BP filed a lawsuit in London against AAR for $362 million in Russian taxes that TNK owed before the partnership agreement was signed. And Hayward says BP would consider going after the partners' international assets. Those are substantial, including mansions in London owned by Khan and another partner, and industrial interests Vekselberg has in Switzerland. "They can't play by one set of rules in Russia and another on the international stage," Hayward says. Nevertheless, he signals he's open to a compromise. "This is Russian negotiation," he says. "At the same time we are firing rockets, we are negotiating."

SETTLING UP

Hayward is banking on what he thinks is a productive relationship with Igor Sechin, the first deputy Prime Minister and chairman of Rosneft, with which BP has a joint venture in Russia's far east. "Overall, we support the work of BP in Russia," Sechin said on July 9 after meeting Hayward in Moscow. "They have introduced new corporate-governance principles, technology, personnel training, and transparency, which makes us very happy." But so far the Kremlin has refused to intervene in what it says is a commercial dispute.

By some measures, TNK-BP isn't that important for BP. While the venture accounts for about a quarter of BP's production and a fifth of its reserves, it will contribute only 7% to 8% of BP's earnings this year. If BP were to sell out, its stake could be worth more than $20 billion, and the dividends BP has gotten so far exceed the nominal value of its original investment.

But it's not easy to see how either BP or AAR can easily escape. When the deal was conceived, it looked like international companies would be flocking to Russia, so if either side wanted out there would be plenty of interested suitors. Because of the Kremlin's slow-motion takeover of the oil sector, though, the only potential buyers are Gazprom and Rosneft, and they're unlikely to pay anything near the market price. That would seem to leave little choice except for the two sides to, as Hayward put it, "sort out the problems like adults and get on with life."

Editor's note: BusinessWeek has learned that BP CEO Tony Hayward and Mikhail Fridman met secretly in Prague on July 30 after the magazine went to press. While the fact that a meeting took place is considered a reason for optimism, there is no sign that a settlement of the dispute is imminent. However, it could be that the departure of TNK-BP CEO Robert Dudley from Moscow on July 24 (BusinessWeek.com, 7/24/08) may make it easier to reach a solution. Dudley's financial plans at TNK-BP have been a major source of friction. Sources close to BP believe that Dudley, a former BP executive who has run TNK-BP since it was formed in 2003, would prefer to move on.

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