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Learning from BP in Russia

It appears the ransom paid by BP for its Siberian gas field was not enough. Today’s news that the company’s investment in the Kovykta field, one of its most important in Russia, is “days away” from having its license revoked provides several clear lessons for energy investors. 1.) There is a “sticky power” to doing business with the Kremlin – foreign firms are drawn into self-perpetuating unlawful and corrupt practices to gain favor with the authorities, mirroring the conduct of a lawless state and its politically guided energy arms. 2.) The further a foreign company is drawn into the state’s embrace, the weaker it becomes and the more vulnerable to the leverage of blackmail. 3.) Weakness, cooperation, and loyalty are not respected – when Russia wants to steal something from you, it is going to go forward and do it, even if you follow their instructions to the letter. 4.) A foreign firm under state attack should fight back hard, and urgently seek to address their claims in fair third-party courts and arbitration forums.

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Shareholders say BP “was not without choices” when confronted with Russia’s energy blackmail. (image: “BP Exec – Nick Turner)

The case in point for British Petroleum’s problems in Russia has a long history – we first started blogging on it last November when their executives came under trumped-up criminal investigations just days after TNK-BP settled a questionable back-tax bill. Like Yukos and Royal Dutch Shell, over the past few years BP has teetered on the brink of suffering major damages from the Kremlin’s gradual and consistent moves to extent majority state control over all of Russia’s most important gas and oil production sites. Now one of the most important natural gas projects in Siberia is being scrutinized by environmental watch (attack?) dog, Oleg Mitvol, the same chief regulator that pressured Shell at the Sakhalin-II project over environmental violations, forcing the companies to give up a controlling stake to Gazprom. (It pretty much goes without saying that once the state gets its desired stake in the project, the environmental concerns disappear.) Mitvol, under Moscow’s instructions, is demanding that BP fulfill its license requirements at Kovykta and begin producing at least 9 billion cubic meters this year. Certainly BP would love to start pumping out that much gas if they had any chance of selling it outside Russia – but due to Gazprom’s monopoly on the pipelines, the gas is currently trapped for distribution to the low-paying domestic market. The Financial Times reports that tomorrow hearings will be held at an Irkutsk court (good luck with that) to determine whether the license requirements actually demand that BP produce 9 billion cubic meters this year, or just enough to meet local demand, which most say is less than 3 billion cubic meters. Essentially Gazprom and its friends in the environmental regulatory agency are attempting to create an crippling financial situation to bleed BP dry, making them produce enormous amounts of gas that they can’t sell. Oleg Mitvol, even if he sincerely believes in his mandate, is being instrumentalized as a veil of legality to make regulatory compliance more costly than the forfeit of a majority stake to the state. But it is difficult to summon up much sympathy for BP. After all, they are probably the most surprised by the ongoing pressure at Kovykta, as they likely considered the matter solved when former CEO Lord Browne paid homage to the court of Putin to present his successor. It was assumed by many observers and shareholders, not just myself, that BP had been convinced to participate in the rigged auctions of stolen Yukos properties to gain favor from the Kremlin – in my opinion, they probably were led to believe that dragging the corporate name through the mud would be a sufficient gesture to end the problems at Kovykta. (apparently it wasn’t enough to throw $1 billion into the Rosneft IPO or form unattractive LNG joint ventures with Russia’s state-owned firms – there seemed no end to what BP is willing to do in Russia to maintain good relations). Yet today Lord Browne’s strategy to ingratiate BP before the Kremlin and maintain proximity to power as the guiding principle to doing business in Russia appears to have thoroughly and tragically backfired. The company has damaged shareholder value, sacrificed its reputation, and helped prop up an increasingly undemocratic regime that beats dissenters in the streets and offers little prospect for fruitful and cooperative relations with the international community.