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Is BP Fighting Kremlin, Russian Billionaires—or Both?

The fate of the second biggest foreign investment in Russia hangs in the balance amid signs of a shifting mood in the Kremlin which may have wrong-footed investors and one of the world's biggest oil companies.

TNK-BP
TNK-BP
TNK-BP

Raided by security services, its board paralyzed, key technical experts barred from working and deluged with court cases and labor inspections, TNK-BP is a struggling $38 billion oil company producing as much crude as Britain.

As investors scrutinize the saga to read the runes for future projects in Russia, signs are multiplying that the root of the dispute may not be in the Kremlin but rather the boardrooms of Russian billionaires. Even that is uncertain.

TNK-BP, a highly lucrative 50-50 joint venture between BP and four Russian-connected billionaires, began in 2003 amid much fanfare in a deal blessed by then-president Vladimir Putin. It produces a quarter of BP's global oil output and posted a net profit of $5.7 billion last year.

TNK-BP's first five years were a success story. Former BP managers working at the venture talk with pride of how they improved management of oilfields using the latest technology, cut back leaks, and boosted operating efficiency.

But its ownership structure, which gives management control to a foreign oil major, became an anachronism following a Kremlin-led drive from 2003 which took back under the state's wing control of all big Russian energy assets.

So when a campaign against TNK-BP suddenly started this year involving tax police, alleged labor code violations, security service sweeps and court cases, many assumed the Kremlin was pressuring the firm to accept a state partner.

A similar barrage of official harassment was unleashed in 2006 against Royal Dutch Shell to force it to sell a controlling stake in its giant Sakhalin gas venture to Russia's state-dominated energy champion Gazprom.

This looked like a replay, but there have been repeated statements from officials, including President Dmitry Medvedev, that the state does not want a stake.

"Something has changed in the past few months... The government has changed. Players have moved around. Power is more dispersed," said a source close to BP, speaking on condition of anonymity like most in this case because of its sensitivity.

Asked what the Kremlin wants out of the affair, one TNK-BP manager shrugged his shoulders: "Nobody knows."

"Grab TNK-BP to sell it later"

Sources close to TNK-BP say there is strong evidence that German Khan, one of the billionaire co-owners and an executive director at TNK-BP, contributed to the official harassment as part of a campaign to weaken BP's control of the firm.

They point to three signals:

* an unauthorized letter from Khan in April to migration authorities asking for the number of permits for foreigners at the company to be cut dramatically. The note contradicted instructions from TNK-BP CEO Bob Dudley.

* when 140 BP specialist staff seconded from BP to TNK-BP tried to return to work after resolving visa problems, office security barred them from the building. Khan is responsible for TNK-BP security.

* a court case launched against TNK-BP over its use of BP secondees in a Siberian court. The suit was launched by Tetlis, a little-known brokerage, two of whose managers used to work in the 1990s at companies in Alfa Group, where Khan and fellow TNK co-owner Mikhail Fridman are partners.

"A lot of my colleagues believe this is about control," one senior BP source said. "They think the Russians want to grab TNK-BP to sell it later at a higher price with control."

Khan has declined to be interviewed, but Fridman says the wave of official action against TNK-BP is normal law enforcement unconnected to the Russian shareholders, and that Khan has also been questioned by officials as part of their checks.

The aim of the Russian shareholders, he added, is simply to improve operating performance at TNK-BP and to remove what he calls a "parallel management structure" inside TNK-BP reporting to BP, which furthers BP interests at the expense of Russians.

"The performance of TNK-BP is just awful compared with its peers," Fridman said, citing the company's shrinking market capitalization and its declining production.

Independent analysts disagree. "We believe TNK-BP Holding's results are strong, confirming its ranking as one of the most efficient oil companies in Russia," said local brokerage Renaissance Capital in a comment this week on 2007 results.

"Will Russia Go the Same Way as Venezuela?"

Did BP Miscalculate the Political Mood?

BP, though, may have been wrong-footed by the shift in political mood in the Kremlin after Medvedev's inauguration in May, pledging to end the expansion of state control that characterized the era of his predecessor Vladimir Putin.

London-based top executives had discussed a possible asset swap with Gazprom involving the Russian partners exiting the venture—but didn't spot the changing mood in Moscow or fully grasp the dangers faced by TNK-BP, industry sources said.

"It took them a long time to wake up in St. James's Square to the problems on the ground," one source close to TNK-BP said, referring to BP's headquarters location. "I don't think they realized how serious the situation was."

Changes had also taken place at the top of BP. John Browne, the smooth international operator who built the company into its present size and masterminded the original TNK-BP deal, had left the company and been replaced by Hayward.

Fridman is very critical of what he terms BP's "arrogance," saying the problems at TNK-BP arose because the British firm was trying to cut a deal with Gazprom behind the Russian co-owners' backs because it thought Gazprom was a "sexier" partner.

"They misjudged if they thought that Gazprom would easily push us out of business," Fridman told Reuters in an interview. "I said many times to (BP CEO Tony) Hayward we are not selling and nobody will push us. It is not the intention of Putin or Medvedev, despite all these rumors."

Hayward has now recalled top trouble-shooter Lamar McKay from the United States to run a round of behind-the-scenes diplomacy ahead of a scheduled July 11 board meeting in Cyprus.

But BP faces a tough challenge to rescue the situation.

Illustrating this, Hayward in early June met the top Russian official controlling the oil industry, former Kremlin deputy chief of staff Igor Sechin, and complained about the Russian partners' tactics.

According to two senior executives with knowledge of the meeting, Sechin called in Khan and Fridman deputy Piotr Aven and gave them a public dressing-down in front of Hayward.

Satisfied, Hayward then flew to the St. Petersburg Economic Forum, Russia's main annual event for foreign investors, and made some optimistic remarks about BP's future in Russia.

On leaving the Forum, he was presented with an ultimatum by Fridman demanding he agree to a sharp cut in the number of BP-related staff in TNK-BP and to an increase in representation for the Russian side on the company's boards.

And having previously asked Hayward to table a proposal for the Russian owners to convert their TNK-BP stakes into BP shares, Fridman then took the proposal and brandished it in front of the Russian press as proof of the British multinational's arrogance in dealing with Russian partners.

"What Fridman did to Tony really spoilt relations," one BP source said. "You can't get over that quickly." TNK-BP insiders, though, felt that Hayward had been too quick to take the Sechin meeting at face value.

BP chairman Peter Sutherland then publicly attacked the Russian partners, accusing them of corporate raider tactics and criticizing the Kremlin for not stopping them.

But after Hayward pulled out of a big investment forum in Moscow earlier this month, criticism of him mounted locally.

"If you don't show up, you lose," said Igor Yurgens, First Vice-President at forum organizer Renaissance Capital. "When the time came for the showdown, BP were not ready for it. With all my frankness I can tell you, they should have been."

"Struggle for The Future of Foreign Investment in Russia"

BP's options are now limited.

If the Kremlin sticks to its public pledges not to intervene and not to take a state share in TNK-BP, and the Russian partners refuse to back down, the British major faces potentially endless litigation and boardroom fighting—unless it concedes to at least some of the Russian demands.

Fridman, whose personal fortune totals $20.5 billion, has a reputation as a shrewd, tough operator who gets what he wants.

BP, in the meantime, seems to be pinning its hopes on a campaign of international pressure to shame the Russian authorities into defending its interests.

"This is a struggle for the future of foreign investment in Russia," one senior manager at TNK-BP said. "The question is: Will Russia go the same way as Venezuela?"

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