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Learning from BP in Russia

BP_art.jpgIn light of the recent BP-Rosneft share swap and Arctic joint venture, we’re combing through our archives to re-publish some of the more interesting moments throughout BP’s tumultuous experience doing business in Russia.  The following post was originally published on May 22, 2007.

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.

The case in point for British Petroleum’s problems in Russia has a long history – we first started bloggingon it last November when their executives came under trumped-upcriminal investigations just days after TNK-BP settled a questionableback-tax bill. Like Yukos and Royal Dutch Shell, over the past few years BP has teetered on the brink of suffering major damagesfrom the Kremlin’s gradual and consistent moves to extent majoritystate control over all of Russia’s most important gas and oil productionsites.

Now one of the most important natural gas projects in Siberia isbeing scrutinized by environmental watch (attack?) dog, Oleg Mitvol, thesame chief regulator that pressured Shell at the Sakhalin-II projectover environmental violations, forcing the companies to give up acontrolling stake to Gazprom. (It pretty much goes without saying thatonce the state gets its desired stake in the project, the environmentalconcerns disappear.) Mitvol, under Moscow’s instructions, is demandingthat BP fulfill its license requirements at Kovykta and begin producingat least 9 billion cubic meters this year. Certainly BP would love tostart pumping out that much gas if they had any chance of selling itoutside Russia – but due to Gazprom’s monopoly on the pipelines, the gasis currently trapped for distribution to the low-paying domesticmarket. The Financial Timesreports that tomorrow hearings will be held at an Irkutsk court (goodluck with that) to determine whether the license requirements actuallydemand that BP produce 9 billion cubic meters this year, or just enoughto meet local demand, which most say is less than 3 billion cubicmeters.

Essentially Gazprom and its friends in the environmentalregulatory agency are attempting to create an crippling financialsituation to bleed BP dry, making them produce enormous amounts of gasthat they can’t sell. Oleg Mitvol, even if he sincerely believes in hismandate, is being instrumentalized as a veil of legality to makeregulatory compliance more costly than the forfeit of a majority staketo 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 Brownepaid 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 convincedto participate in the rigged auctions of stolen Yukos properties togain favor from the Kremlin – in my opinion, they probably were led tobelieve that dragging the corporate name through the mud would be asufficient gesture to end the problems at Kovykta. (apparently itwasn’t enough to throw $1 billion into the Rosneft IPO or formunattractive LNG joint ventures with Russia’s state-owned firms – thereseemed no end to what BP is willing to do in Russia to maintain goodrelations).

Yet today Lord Browne’s strategy to ingratiate BP before the Kremlinand maintain proximity to power as the guiding principle to doingbusiness 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 beatsdissenters in the streets and offers little prospect for fruitful andcooperative relations with the international community.