How BP Learned to Dance with the Russian BearStanley Reed
In July 2008, Robert W. Dudley, then chief executive officer of TNK-BP, a joint venture between Britain's BP (BP) and a group of Russian billionaires, hastily left Russia after complaining of "sustained harassment" from his local partners. Dudley had been driven to flee the country by a barrage of lawsuits, tax probes, difficulties obtaining work permits, and other legal pressures that became a hallmark of the acrimonious partnership's battles over management control and investment direction. One Russian court even barred Dudley from performing his job for two years for allegedly violating local labor laws.
How times have changed. On July 27, the very day Dudley was tapped to replace Tony Hayward as BP's chief executive, he got a congratulatory phone call from Mikhail Fridman, the Russian oligarch who is TNK-BP's executive chairman and interim CEO. Fridman jokingly offered to help Dudley get a Russian visa. Soon after, Dudley and Hayward, who will join TNK-BP's board, flew to Moscow to meet with Fridman, one of Russia's richest men. "The attitude of BP toward TNK-BP has changed," Fridman said in an interview at his Moscow office. "We had an intense dispute. We think TNK-BP should not be a BP branch."
Now, with three independent directors added to the board, including former German Chancellor Gerhard Schröder, and the appointment of a 36-year-old Russian, Maxim Barskiy, as CEO, that's no longer an issue. Explains David Peattie, head of BP Russia: "There is a different attitude on the part of both sets of shareholders. Now TNK-BP...is able to be more independent."
The rapprochement couldn't come at a better time for BP. TNK-BP, which used to look like a huge headache, now seems like a godsend, providing cash-pinched BP billions in dividends annually, huge reserves of cheap-to-raise oil, and a safe haven from the blistering criticism it's received in the U.S. over the handling of its huge spill in the Gulf of Mexico. Russians are "more philosophical" about such mishaps, says Fridman, adding that BP helped improve safety at the Russian unit. "We know this business generates situations like that."
TNK-BP is a major oil company in its own right, producing about 1.9 million barrels per day of oil. That's about half what BP produces and triple the output of large U.S. independent Anadarko Petroleum. BP's share of TNK-BP's production accounts for about one quarter of its own output and a fifth of its reserves. For the first half of 2010, production at the joint venture rose a strong 4.5% from the same period in 2009. TNK-BP pays close to $2 billion in yearly dividends to each of its ownership groups—cash BP needs.
Both sides now seem to recognize their co-dependence: The Russians need BP's expertise while the Brits need access to Siberia's cheap crude. So BP has backed off, allowing Fridman and his partners to largely run the company their way. The biggest change is a willingness to allow TNK-BP to expand widely abroad. BP was long skeptical of TNK-BP operating beyond the former Soviet Union, which would take the venture into areas where BP has extensive operations of its own. Now the two sides are discussing TNK-BP buying BP assets in Venezuela, Vietnam, and Algeria.
As a Russian company, TNK-BP may be better positioned to work with contentious governments such as that of Hugo Chávez in Venezuela. "I don't doubt that a Russian company has more leverage with Venezuela than BP, so from that point of view this makes sense," says Artem Konchin, an analyst at Unicredit Securities in Moscow.
Moreover, BP executives figure such sales could be a painless way to raise cash to help pay the expected tens of billions in costs related to the Gulf spill. BP plans to raise $30 billion through asset sales over the next 18 months. Selling to TNK-BP would not only raise cash but, as 50% owner of the venture, the London-based company also would retain influence over management and development of the assets. This "means there is no need to sell to a competitor and make them stronger," Fridman says.
That portends big change at TNK-BP. Fridman says he would eventually like to see the joint venture's dependence on Russia cut in half from its current 100 percent. Right now, the company's biggest opportunities lie inside Russia, the world's largest oil producer. TNK-BP's challenge is to maintain production levels at its mainstay Soviet-era oil fields in West Siberia and the Urals while bringing on promising new fields in areas such as Siberia's Yamal peninsula.
The heart of TNK-BP is Samotlor, a sprawling 700-square-kilometer oil deposit lying beneath sandy swampland near Nizhnevartovsk in West Siberia. Samotlor was discovered about 40 years ago and once held about 55 billion barrels of oil. The field now requires that tremendous quantities of water be pumped into its reservoirs to maintain adequate pressure for oil extraction. Although the liquid produced by the wells is 95% water, Samotlor still churns out about 560,000 barrels per day—one-quarter of TNK-BP's total production.
The company's oil fields are money-spinners because of their rock-bottom operating costs. Samotlor wells cost only $1 million to $2 million to drill, for a mere $2.20 a barrel finding cost. A new field called Ust Vakh was recently developed by the joint venture near Samotlor at a cost of about $1 billion; it paid for itself in only 18 months, according to Vitalyi Federov, TNK-BP's head of long-term planning. And Chief Operating Officer Bill Schrader, a BP veteran, says the Yamal could produce up to 900,000 barrels a day in 10 years if adequate pipelines can be built. Given those prospects, Dudley has every reason to dance with the bear.
The bottom line: As its prospects in the Gulf of Mexico dim, embattled BP can turn to its TNK-BP joint venture for cash and growth.