BP Has Upper Hand in TNK-BP Saga

RelevanceThe Guardian’s analysis of the TNK-BP saga on 26 July is superficial, ignores the realities of the international oil business, and draws conclusions that are not based in fact. The fact is that BP has turned TNK-BP into the best performing of Russia’s domestic oil businesses. In doing so it has profited handsomely, achieving payback on its initial investment in 4 years – something other international investors are not even close to doing. Russia contributes to a large share of BP’s production, but a low share of its profits. A trade sale by BP of its share in TNK-BP would raise between $16b and $20b, according to two independent western observers (surely Russia is not considering expropriation in this case?). These funds could be more usefully reinvested elsewhere. Talk of a merger with Shell is old news and preceded the Texas City incident. BP’s environmental and safety performance is at least as good as its peers. None of this leaves the firm susceptible to takeover.

AnalysisThe deal that BP signed to create TNK-BP in 2003 was a great deal for the company. BP has already covered its cost of acquisition in a very speedy 4 years, thanks to a very healthy dividend stream from TNK-BP. None of the other major integrated oil companies in Russia is even close to payback. Margins at TNK-BP are well above its domestic peer group.

That BP-TNK is outperforming its Russian peer group is in little doubt. It has the best track record in Russia on all measures taken seriously by investors. It has the largest organic growth rate of any large Russian oil company. Production rose in the last 3 months to June for the third successive quarter (according to a statement by BP reported in the FT). It also has the highest reserves replacement ratio, lowest F&D costs and highest return on capital. TNK-BP has paid out about $18b in dividends, paid $70b in taxes and improved HSE performance.

All this is due in large part to the injection by BP of technology and knowhow into the TNK-BP joint venture. The very individuals whose work permits have now been denied can take some (small) consolation that it was they who have achieved this success.

AAR’s first complaint is that the foreign (i.e. western) workers are too expensive. Sure, they are not cheap. But AAR is happy to overlook the value that they bring. AAR’s second complaint is that TNK-BP is not internationalizing (a complaint that AAR seems to rationalize by claiming that such internationalization would bring TNK-BP into direct conflict with BP). And yet the TNK-BP shareholder agreement clearly states that the intent of the JV is to do business in Russia and the Ukraine. As it happens, 9 international opportunities have been considered, and 5 projects are being developed. TNK-BP has offices in Turkmenistan, Venezuela and Kazakhstan.

It seems a little odd that AAR should consider investment in Russia limiting, and anyway, AAR has the option to directly reinvest abroad its rather large dividend stream from TNK-BP, if it is not happy with the pace of internationalization.

It is patronizing of industry observers and commentators to claim that BP has been naive in the extreme in dealing with Russia, or that it made the original investments unaware of the risks it was taking on. This risk is part and parcel of being an international oil company. BP should know, it had assets nationalized in 1951 (Iran), 1971 (Libya) and 1979 (Nigeria). IOCs have faced such action in the past and have recovered and returned even stronger.

AAR’s tactics are a return to pre Putin Russia. The early 1990s in Russia were characterized by corporate raidings. AAR’s actions can be seen as an attempt to destabilize TNK-BP, overturn the joint venture agreement and to take control. AAR will use local contacts and influence (e.g. within the judicial system) to further its aims.

Despite their insistence that the TNK-BP saga is a matter for the shareholders, Putin and Medvedev must be looking on in horror. The Russian stock market was down a sharp 5.5% on the day of Dudley’s (TNK-BP CEO) departure. Foreign investors must be taking a rather dim view of proceedings. As such, the TNK-BP affair is rapidly turning into a test case for foreign investment into Russia. The world needs Russia to be fully integrated into the world economy and Russia needs foreign investment (particularly as its production is falling at a time when there is relative weakness in the oil price).

So, what should BP do? In the worst case BP could conduct a trade sale of its share of TNK-BP. This would realize between $16b and $20b according to two independent western analyzes. Some BP shareholders may consider this to be a very good outcome. Russia accounts for 25% of BP’s production, but only 10% of its profits (due to domestic price controls and tax). The clear implication is that Russia is less valuable to BP than other parts of its portfolio. Stripping out TNK-BP from BP would still leave the firm with a solid reserves position. Funds raised from a trade sale could be reinvested in more attractive opportunities in Angola, GOM and Canada.

However, withdrawal from TNK-BP is unlikely. Russia presents a huge long term opportunity to companies such as BP, and the country needs outside investment. Other IOCs may take some quiet satisfaction at BP’s troubles, but they would be wrong to do so. Failure of BP in TNK-BP will postpone IOC investment, and significantly reduce all foreign investment, for a great deal of time.

The original BP investment in TNK-BP was very publicly blessed by Putin. It seems that he (or Medvedev) will have to intervene again, despite their reluctance.

 

29 July 2008

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