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Boardroom Brawl Roils BP’s Russia Venture

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Boardroom Brawl Roils BP’s Russia Venture

Talks Break Down; Kremlin’s Role Murky
June 12, 2008; Page A1

MOSCOW — BP PLC thought it had cracked the code of doing business in Russia. Now its Eastern front is crumbling.

The British oil major’s $7.6 billion TNK-BP Ltd. joint venture has been wracked for weeks by escalating, open warfare between BP and a group of Russian billionaires that owns half of the company. On Wednesday, talks between the co-owners broke down, after the British side rejected the Russian camp’s proposals to resolve the dispute.

[Tony Hayward]

The Russian owners, who demand the ouster of the venture’s BP-appointed chief executive, said Wednesday they are planning legal action to defend their interests. Each side accuses the other of trying to wrest control over the company by stealth.

BP’s Russia dilemma is a familiar one to Western oil majors as they seek to expand overseas: All must balance the desire to control their operations with the necessity of not rocking the boat in host countries that are increasingly protective of their resources.

For its expansion into Vladimir Putin’s Russia, BP took an aggressive course. Unlike other Western oil companies that kept their distance from the Russians by seeking minority stakes or management control, BP went native. It formed a 50-50 joint venture with the local billionaires, aggressively courted the Kremlin and effectively became a Russian company.

The approach looked golden for several years, as BP gained the kind of foothold in Russia — the world’s No. 2 oil exporter — that has eluded rivals. The Russian venture has accounted for one-quarter of BP’s global production in recent years.

BP says it isn’t losing hope of reaching an agreement with its co-owners. “I believe there will be a deal,” said Tony Hayward, BP’s chief executive. “But it’s going to take some time.”

BP offered in recent weeks to buy the Russians out. Publicly, the Russians say they have no plans to sell, but people close to the talks say they’ve discussed the possibility of swapping their TNK-BP shares for shares of BP. The British side has said that as part of such a deal, it would quickly resell a majority stake in TNK-BP to a Russian state-owned giant such as OAO Gazprom.

BP’s bear-hug strategy was a gamble from the beginning. In the late 1990s, the company was embroiled in a string of commercial catfights with three Russian billionaires — Mikhail Fridman of Alfa Group, Len Blavatnik of Access Industries and Renova’s Viktor Vekselberg. The trio had used Russia’s weak courts to seize assets from BP’s Russian venture, a company called Sidanko. BP lined up support from top officials in Washington and London but still wound up writing off half of its investment.


Yet in 2003, BP decided to team up with a holding company owned by the same three businessmen, called AAR, to create a British-Russian oil giant. “Of course we had qualms, given the history,” says a BP executive. “But sometimes you don’t get the chance to choose your partners. It was the only deal available.”

Strategic Triumph

The deal soon looked like a strategic triumph for BP’s then-CEO, John Browne. For $7.6 billion, BP got a 50% stake in one of Russia’s biggest producers, Tyumen Oil Co., or TNK. Vital for both sides was Mr. Putin’s public approval of the pact. He presided over the signing ceremony with British Prime Minister Tony Blair.

Lord Browne was aware of the risks. “There is a toughness built into the culture of Russia,” he said at the time. “You have to cooperate.”

Production at TNK-BP took off. The joint venture provided desperately needed new reserves for BP. Surging dividends from the operation paid off the British major’s investment in less than five years.


BP and its partners had agreed to share management duties. BP had the right to nominate the venture’s CEO, choosing Robert Dudley, a mild-mannered Illinoisan and veteran of U.S. oil major Amoco. Two key slots in top management went to Russian shareholders — Mr. Vekselberg and German Khan, a founding partner of Mr. Fridman’s Alfa Group, who was known for his toughness and a fiery temper. A confidential shareholders’ agreement detailed specific powers for each executive. Mr. Khan, for example, was given control over government relations, legal affairs and security.

“In a normal corporation, the CEO can order his subordinates to do what he wants,” said one person who was involved in the process. “But in this company, he can’t.”

A top BP executive warned at the time that it would be “a big mistake” to let Mr. Khan into management. But the concession was necessary to close the deal. Mr. Khan declined repeated requests for comment.

Tuesday-afternoon meetings of the management board turned into marathon battles, according to participants. “There was a lot of screaming,” said one. This person recalled that Messrs. Khan and Vekselberg would fight Mr. Dudley over corporate policy and strategy late into the night.

They argued over the deal’s payment terms. BP had agreed to pay half the venture’s price to the Russian partners in three annual payments of BP shares. BP viewed the arrangement as a way to keep the Russians committed to the business. The Russians, unwilling to tie up so much money in BP stock, found an investment bank to convert the promised payments into cash up front. BP officials saw that move as bad faith.

[Mikhail Fridman]

Still, TNK-BP thrived as oil prices surged. Production grew by as much as 13% a year thanks to a BP-provided technology that helped get more crude from aging fields. In 2005, the Russian billionaires each taped warm greetings for a birthday DVD for Mr. Dudley, hailing his performance, says a person who saw it.

Around the same time, the Kremlin was asserting control over Russia’s oil patch. A government inquiry into tax evasion and fraud at OAO Yukos ended in the effective nationalization of the big private oil company. In 2006, environmental regulators threatened to shut down a vast oil and gas project off the Far East island of Sakhalin operated by Royal Dutch Shell PLC. Shell was forced to sell half its stake to state-owned Gazprom.

BP, meanwhile, was courting the Kremlin’s favor, working hard to lend legitimacy to the state push into the oil and gas industry. In 2006, it spent $1 billion to buy shares in the initial public offering of Rosneft, the state oil company, helping make the sale a success. TNK-BP also took part in a controversial 2007 auction of assets from Yukos.

Kremlin Ties

Such Kremlin ties helped BP, government and company officials say. TNK-BP was hit with a big back-tax claim in 2005, sparking fears it would meet the same fate as Yukos. But the Kremlin stepped in and the bill was reduced, a former senior Russian official says.


[Robert Dudley]
Associated Press
Robert Dudley leaves Interior Ministry Tuesday
February 2003: BP announces new Russian oil joint venture, TNK-BP, with three Russian billionaires
June 26, 2007: BP agrees to sell stake in Siberian gas field to Gazprom and form global joint venture
March 19, 2008: Russian security services raid offices of TNK-BP and BP in Moscow
March 21: Russia’s environmental watchdog says it’s launching a probe of TNK-BP’s biggest oilfield
March 25: Interior Ministry says it’s investigating a tax-evasion case against one of TNK-BP’s former units
May 13: TNK-BP says a Siberian court, acting on a Moscow brokerage’s request, has issued an injunction preventing BP specialists from working in Russia
May 26: TNK-BP CEO Robert Dudley admits publicly that TNK-BP’s Russian and British shareholders have disagreements
May 27: Russian shareholders issue statement admitting to differences with BP on strategy, slamming Dudley for going public
May 30: Russian partners demand Dudley’s ouster, scheduled board meeting fails to take place
May 31: Russian Prime Minister Vladimir Putin says he warned BP about the risks of setting up a 50-50 joint venture in Russia
June 5: Russia’s deputy prime Minister presides over talks between BP CEO Tony Hayward and two Russian shareholders of TNK-BP
June 6: Hayward meets Mikhail Fridman, one of the Russian partners
June 8: A Russian government official says BP’s conflict with its Russian partners is likely to get worse
June 10: Dudley questioned as a witness by the Russian Interior Ministry in a tax investigation
June 11: Talks between BP and its Russian partners break down. The Russians say they will sue BP

Tensions continued to simmer between the venture’s partners, however. Russia’s tightening grip over energy meant new opportunities there were limited for a half-foreign-owned company. The Kremlin, meanwhile, was encouraging local tycoons to expand overseas.

A person close to BP said the venture’s Russian partners proposed refining and distribution projects in Poland, Lithuania and beyond, contending that doing so would please the Kremlin. BP’s representatives on the board of directors shot them down, arguing that TNK-BP had more promising projects in Russia, both sides confirm.

The Russian shareholders insist the foreign deals were attractive. They say BP has resisted because it doesn’t want to see TNK-BP as an international competitor.

Tensions rose last fall when Mr. Dudley rolled out a five-year plan for the venture. He warned that output would be stagnant until new projects come on line after 2009, and high taxes and surging costs would cut into profits. New developments would require heavy investment. Shareholder returns in 2008 would be 4%, less than half of past years’ levels. BP officials described the drop as natural in a cyclical business.

The Russian shareholders, used to 20%-plus returns from their other businesses, were livid. They say they suspect Mr. Dudley was running TNK-BP in the interests of his ex-employer BP. Mr. Dudley was less focused on TNK-BP’s profit, they say, than on the reserves and production that the venture contributes to BP’s own profile.

“There’s a strategic conflict of interests between TNK-BP and BP itself,” Mr. Fridman said in an interview.

The Russian shareholders refused to approve the business plan — and began to push privately for the removal of Mr. Dudley. “We had a company that was strong, energetic and aggressive in the good sense of the word,” Mr. Fridman said. “BP turned it into a typical bureaucracy.”

The push against Mr. Dudley picked up in October 2007, when President Putin complained to legislators about a dearth of Russians in top positions at the country’s biggest natural-resource companies.

“Our partners came in immediately waving a copy of speech, saying we need to get rid of the foreigners,” said a person close to BP.

Roughly 300 foreigners were then working at TNK-BP, most with rich pay packages that the Russian shareholders said were demoralizing to local staff. BP said the foreigners, a tiny minority in a company of 60,000 employees, provided vital skills.

Executives appointed by the Russian shareholders ordered security workers to block some expatriate workers’ access to their offices. They slashed the number of government work permits the company sought for foreigners. Last month, an obscure Moscow brokerage provided an unusual assist: It argued to a court in the venture’s home city of Tyumen that payments to BP employees seconded to TNK-BP amounted to illegal dividends to BP. The court forbade TNK-BP from paying these foreign workers.

TNK-BP was under siege on other fronts. On March 20, authorities announced they’d arrested a low-level employee on industrial-espionage charges. The next day, environmental regulators launched special checks of TNK-BP’s fields. A few days later, prosecutors investigated possible criminal charges in long-resolved back-tax cases.

Some industry analysts said the crescendo of complications looked like a repeat of the 2006 attack on Shell. BP officials believed they were still on the Kremlin’s good side. They figured the Russian shareholders had instigated pressure from lower levels of the government.

Mr. Dudley and Mr. Khan, who sit in facing offices, were by now engaged in what one witness described as “a cold war.”

“It’s like trying to fly an airplane flat with people trying to grab the controls all the time,” Mr. Dudley told people inside the company.

Going Public

Late last month, Mr. Dudley took the shareholder conflict public with an interview in a Russian newspaper. Days later, before a board meeting in a hotel in Limasol, Cyprus, BP’s representatives demanded the removal of Mr. Khan and allies who run the security and legal departments, citing “gross insubordination.”

The Russian shareholders responded by calling for Mr. Dudley’s removal.

[German Khan]

Directors friendly to BP — who account for five of the venture’s 10 board seats — refused to entertain the dismissal motion. The Russian shareholders decamped, leaving the board meeting without a quorum.

BP viewed AAR’s criticisms as smokescreens. The Russians’ real agenda, according to several officials close to BP, was to wrest control of the venture to strengthen their hand in possible talks to sell out to a state company like Gazprom.

“They’re faced with the problem of how do they get value, liquidity and an exit,” says one BP official.

The Russian shareholders say they want to stay in the business. They say they want to raise the value of their stake by expanding internationally and improving management.

Last week, the Russian shareholders proposed a deal giving them the option to swap their TNK-BP shares to BP for stock in the British company to better align their interests. Such a deal would leave BP with majority control of a Russian oil company. People close to BP say they would consider such a proposal only if the Kremlin would bless it, and offer to immediately allow BP to sell control of TNK-BP to a state company.

The Russian shareholders accuse BP, meanwhile, of discussing the fate of their stake in its secret negotiations with Gazprom. People close to BP confirm the discussions.

Strategic Challenge

The confrontation has been the most serious strategic challenge to Mr. Hayward, the pragmatic and low-profile BP veteran who replaced Lord Browne as CEO last year. In private, Mr. Hayward and his colleagues were livid about their partners’ behavior. Mr. Hayward called Mr. Fridman and the others repeatedly to complain. BP officials also bemoaned their plight to Russian officials, but got little sympathy.

Mr. Hayward didn’t want to go on an open offensive, for fear of jeopardizing BP’s good relationship with the Kremlin, say people close to the company.

On June 5, a week after the blow-up at the Cyprus board meeting, Mr. Hayward headed to Moscow on a previously scheduled trip. He hoped to meet top government officials, as well as the Russian shareholders, to work a way out of the impasse. Mr. Hayward kept his public comments deferential.

Mr. Hayward complained more openly in a private meeting with Igor Sechin, who is the chairman of the board of Russian oil major Rosneft’s board and, as deputy prime minister, Russia’s top oil official. Mr. Hayward told him that BP’s Russian partners were causing havoc at TNK-BP. According to people familiar with the meeting, Mr. Hayward cited BP’s suspicions that the partners were behind the lawsuits and other pressure.

Mr. Sechin, a close confidant of Mr. Putin who is considered one of Russia’s most influential people, called in Mr. Khan and another partner from Alfa. After both sides laid out their versions of the conflict, Mr. Sechin promised BP that while he could only do so much, he would try to prevent the most extreme misuses of regulators and courts. But he told both sides that they were “big boys and would have to sort it out,” according to a person familiar with the meeting.

Mr. Sechin declined repeated requests for comment.

Mr. Hayward and his colleagues emerged from that encounter encouraged that their position had been heard. The Alfa partners interpreted Mr. Sechin’s warning as a formality, say people familiar with their thinking.

“Mr. Hayward is a new CEO and it’s not easy for him,” says Mr. Fridman. “That’s one of the fundamental reasons for the difficulties.”

BP’s message clearly wasn’t getting through. Top Russian officials echoed Russian shareholders’ allegation that BP was holding back TNK-BP from international expansion to avoid competition. A senior government official told reporters BP “probably did not understand who they formed a partnership with.” He warned that pressure on the company was likely to increase, suggesting that BP’s efforts to get the Kremlin to help rein AAR in had failed.

Pressure on the venture resumed early this week, when prosecutors demanded boxes of personnel records, responding to a complaint by a union about overpaid expatriate workers of TNK-BP.

The next day, Mr. Dudley spent five hours with investigators being questioned about a back-tax case concerning the venture’s Russian predecessor company. BP says it is still hoping AAR will accept its proposals, including a move to restructure TNK-BP’s management and an arrangement to ease out Mr. Dudley.

Mr. Fridman says the Russian shareholders want to replace management at TNK-BP with new, independent executives, and add outside directors to the board. “We don’t plan to leave and I don’t think that they plan to leave,” Mr. Fridman said. “So ultimately we’re destined to come to some agreement.”



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