(Russia) TNK-BP 2008
INTRODUCTION This case portrays the highly uncertain scenario facing BP in Russia at the end of 2007. In the midst of unraveling relations with its cooperative partner and undesirable host government practices, ideal strategic conditions are implausible. In order to maximize outcomes under such imperfect circumstances, BP's senior management needs to fully assess the situational risks, understand the dynamics and motivations driving stakeholder behavior, and establish a plan which can appeal to all interested parties. 1. As BP devises a strategy for managing business holdings in Russia, what risks does the company face? 2. What important motivational factors are underlying the behavior of prominent stakeholders? 3. What steps should BP take to protect its investments and ongoing global operations? ANALYSIS Environmental Threats Due to globalization, there is an increasing economic interdependence across national borders. The flow of goods, financial capital, and knowledge among countries is growing, and international performance standards are on the rise. Interesting and promising opportunities are associated with the emergence of the global economy, but they are not without related risks. BP is the world's third largest oil and gas concern, holding a diverse range of international pipeline, refining, chemical, and retail assets. In the oil and gas industry, competitiveness depends on continually increasing oil and gas production and replacing reserves. Reserves are limited globally, which restricts options available to industry participants. The size, importance, and potential of the oil industry in Russia is a big draw for companies like BP -- especially as the company tries to match the financial performance of mega-rivals, ExxonMobile and Shell. To access key supplies of raw material, BP has taken steps to secure important resources within Russia. But, despite the strengths of its Russian assets and operations, the company has not been able to meet the growth level it is seeking. Oil production is actually decreasing in Russia due to:
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aging and poorly-maintained oil fields, the confiscatory tax and regulatory regime, and deficient investments (both Russian and foreign) in new exploration and development.
In Russia, much of the risk faced by BP is concentrated in the political and legal segment of the general environment. Oversight of vital natural resources is intense, and government policy is volatile. Revenues are negatively impacted by heavy export duties TNK-BP - 1
TNK-BP (Russia) 2008
and a complex domestic pricing structure. Sociocultural and institutional attributes have also interfered with BP's integration in the Russian oil and gas market. Government and partner tactics being used in Russia should be of grave concern to BP executives. Government leaders use gas exports as a means of achieving foreign policy objectives and manipulating international political events. The majority of oil and gas companies in Russia are controlled by the state, and complex relationships between officials and company principals greatly influence policy and regulatory actions. Even AAR's use of its political connections puts BP at a disadvantage. For instance, labor laws are currently being exploited to drive out foreign managers and specialists so that TNKselected leadership can be strengthened and AAR objectives can be prioritized. Nationally, foreign managers are being driven from firms which own critical natural resources to increase the number of Russians in top management positions. As the government systematically rejects visa renewals, BP runs the risk that its leaders will be permanently removed from joint venture operations. A true outsider, BP is the only major foreign party with an ownership stake remaining in the industry. The company is banking on Russia's commitment to adopting international rules of trade, but political leaders vacillate in their positions, and the legal system follows. BP is vulnerable to the loss of existing exploration and production licenses. Current Russian laws limit foreign investment in strategic industries, including ownership in major oil and gas fields. The country's natural resources minister no longer allows foreign-owned companies to participate in auctions for new oil fields. And it is not uncommon for authorities to manipulate legal requirements to force the transfer of ownership control to state-owned firms (i.e. Shell to Gazprom in 2006) or to dismantle out-of-favor firms. Russia's weak judicial system gives foreign interests little legal recourse to ensure property rights or to fight against state-allowed corporate raiding practices. Most recently, the threat to revoke Rusia Petroleum's license for the Kovykta oil field and the refusal to develop a planned pipeline to China pressured TNK-BP to sell the subsidiary to Gazprom for a fraction of its value. Perhaps most importantly, nearly all of BP's Russian assets are tied to the alliance. The company risks losing control of them if the cooperative is forced to give BP a minority stake or if private assets are otherwise nationalized. The possible loss in investment is great, but the loss in access to reserves has the potential to harm the long-term viability of BP's global business. As unfavorable events escalate and unfold, the situation is becoming almost untenable. The company's ability to manage, and perhaps to maintain control of, its asset base in this unfriendly environment is at real risk. Exit barriers and strategic stakes are high. To remain in the market, BP will need to build stronger local relationships and improve its ability to function within the sociocultural and political environment of Russia. For starters, the firm needs to understand the motivating factors which are driving shareholder and national leader actions. Stakeholders AAR. Simply put, the joint venture's Russian shareholders are motivated by greed. They are large investment and business developers who use their wealth and political power to achieve personal objectives. They are driven by the desire to maximize TNK-BP - 2
TNK-BP (Russia) 2008
the financial results of TNK-BP, which they believe comes from cost control, higher profits, and increased growth. A critical tenet of these beliefs is that achieving their objectives depends on expansion outside of Russia. Upon entering the partnership agreement back in 2003, Fridman openly communicated the desire to "participate in the world oil industry". In addition to BP assets, access to the company's experience, managerial expertise and judgment, credibility, global position and connections, and advanced technologies is also fundamental to achieving their goals. The desire for 2008 investment and 5-year strategic plans which better match their values lies behind shareholder attempts to remove Chief Executive Robert Dudley. And emphasis on reducing expatriate compensation, bonuses, and entitlements is an exercise in eliminating excesses which are culturally distasteful to the Russians. BP. Success of TNK-BP is critical to the achievement of BP's oil production growth and replacement reserve objectives. Access to reserves in one of the greatest oil and gas provinces of the world is essential to the company's international competitiveness and financial performance. Not only does Russia have sizable reserves, but there are great opportunities for further exploration and new oil discoveries. In addition to establishing a lasting presence in Russia, it is crucial for BP to protect its Russian assets, which account for 25% of the company's oil production and 20% of its reserves. As stated previously, most of BP's Russian assets are now owned by the cooperative. If the company is forced into a minority position in the joint venture, it would essentially lose control of these assets. Russia. Like other host governments in oil-producing nations, Russia is seeking the best contractual terms to maximize the financial benefits earned from its reserves. At 50% of budget revenues, 65% of exports, and 50% of foreign investment, oil and gas revenues provide Russia with stability and economic clout. International recognition of rising political stability and progress in economic development will help the country attract and support foreign investment and integrate with the world economy, but these are not clearly-defined objectives of the Russian government (at least as presented in the case material). Even though Western nations and BP leaders believe that it is in Russia's best interest to attract professionally-run, modernized companies capable of competing in the world marketplace, the country's legal measures and political actions show that the country is motivated by generating revenues and protecting strategic natural resources which can be used for international posturing on issues of national importance. Where foreign ownership of substantial assets in important oil-bearing areas is concerned, Russia has been active in decreasing these stakes. It can be assumed that efforts to push for development in Eastern provinces (such as at Kovykta) are not specifically punitive, but are most likely guided by the desire for higher revenues and the willingness to act in the interest of political allies. COOPERATIVE STRATEGY Engaging in strategic alliances is a favorable approach for entering new markets. Especially when faced with high levels of uncertainty, connection with an experienced partner can be of great value. But sharing resources and risks does not always guarantee compatibility or integration preclude problems. TNK-BP - 3
TNK-BP (Russia) 2008
Collectively, TNK-BP employs 65,000 people and is the third largest oil and gas concern in Russia. Its oil production and gas processing assets account for 20% of Russia's total oil production. The joint venture is a 50-50 partnership which combines AAR's human resources, political connections, and cultural knowledge of the country with BP's Russian assets, retail network, equity investments, and expansive management expertise. The escalating conflict of interest between the two partners is now moving into the legal domain. And as discussed above, this puts BP at a disadvantage. There is no way around it. The company strategically depends on the success of the joint venture. Representing 25% of BP's oil production and almost 20% of its reserves, failure would have serious and far-reaching financial implications for the company. BP needs Russian oil production and reserves in its global portfolio to enable strong performance in the industry over the long-term. With TNK-BP's lock-in period expiring on December 31, 2007 and with the ongoing conflict between the parties, it is logical to pursue new terms for the joint venture at this time. Every attempt should be made to structure the agreement to provide greater value for all stakeholders. In order to build a partnership of mutual advantage, BP needs to recognize the motivating factors of each party and to accept some very jarring facts. It is increasingly unlikely that the company will be allowed to maintain a majority holding or to attain licenses to participate in new reserve discoveries in Russia's strategic oil industry. So long as conditions remain the same, the company will continue to be the target of restrictive government measures and state-owned company attacks. These inconsistent conditions (the need for a presence in Russia and existing ownership restrictions) are likely to force BP into a non-traditional arrangement in order to retain access to strategic resources in Russia. However, it has been established that taking a minority stake in the joint venture is not an option. It would be the equivalent of giving away BP's valued assets in Russia. In renegotiating the partnership, the company should focus on the following elements. Remove Negotiating Obstacles: Structure compensation packages for foreign executives in Russia which are consistent with local customs. Recognize that U.S. practices are distasteful to Russian partners, and respect their cultural values. This will be just one step in narrowing the cultural gap between Western and Russian styles of doing business. To properly reward expatriates and continue to provide competitive pay, structure a portion of manager benefits to come from corporate BP funds. While commitment to growth and efficiency and the importance of sustainable renewal are shared by both AAR and BP, the degree of growth outside of Russia is a major area of contention. The company needs to be willing to structure an agreement which allows business scope expansion beyond Russia and Ukraine. Geographic or business assets which are complimentary or offer synergistic value should be matched with expansion goals. Selection of the appropriate assets can be strategic to minimize conflict with other divisions or BP initiatives and to gain new benefits for the BP portfolio.
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TNK-BP (Russia) 2008
Postulate Negotiating Advantages: BP's most important bargaining chip is the undisputed and unmatched performance of TNK-BP. At 74%, the joint venture's return on equity is unequaled in the region, emerging markets, or developed markets. It is triple the global average RoE. Returns on assets and invested capital are also strong and unrivaled globally. The alliance has clearly created a collaborative advantage. But without BP's resources and business acumen to optimize recovery and efficiency, these types of results would not be possible for investors, and revenues for the state would suffer. And this performance is accomplished with only 85 managers out of a workforce of 65,000 and with the constraints of working mature oil fields. BP is a powerful, global network of capital which is capable of helping both the Russian partners and authorities to attain their respective objectives. It is worthwhile to draw attention to the fact that BP makes only 10% of its net income from its Russian operations (which, again, are 25% of oil production and 20% of reserves). TNK-BP's EBITDA is zero. There is an opportunity cost for operating in Russia, and an expectation for higher earnings is a reasonable position to take. Alternatively, companies investing in the markets of emerging countries are generating an attractive 14% EBITDA. In addition, Russian firms are having difficulty integrating internationally. Working with BP is a vehicle for building acceptable trade practices beyond domestic borders and demonstrating international cooperation. Protect BP Interests: Cooperative strategies are typically a viable engine for organizational growth. However, at this time, TNK-BP is not satisfying the company's growth objectives. The terms of the partnership agreement need to specify strategic measures of performance in addition to clear financial metrics. BP needs to again encourage the exercise of proper corporate governance and the concepts of transparency, safety, and ethics. Governance mechanisms are meant to align owner interests with manager interests and to improve relationships among stakeholders. By establishing Board oversight of strategic planning and financial projections, fairness and a voice for all shareholders can be assured. Even though all terms may not be enforceable through legal authorities in Russia, values consistent with international trade standards will be reinforced, and their importance will be emphasized. To alleviate pressure from the state, the company should consider an alliance structure which puts BP in control of only non-strategic portions of the supply chain, such as processing and distribution. Would shareholders and Russian officials care who buys the end product so long as satisfactory profits and revenues are achieved? BP should also consider entering additional strategic partnerships with other oil groups to develop an expanded alliance, social, and political network in Russia. Further investment in Russian assets should be done with great caution. And if unfavorable or unacceptable terms cannot be established to protect its own interests, BP needs to be prepared and willing to pull out, which means selling the assets associated with its Russian oil reserves. TNK-BP - 5
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With the priorities, guidelines, and measures outlined above, BP should be able to improve the likelihood that the TNK-BP agreement will continue to provide the company equal director representation, a voice in executive selection, and strong managerial participation in joint venture operations. The continued use of a contractual costminimizing agreement (which specifies how the cooperative strategy is to be monitored and how partner behavior is to be managed) is recommended to minimize costs and opportunistic behavior. However, formal contracts and monitoring systems can stifle the identification and pursuit of value-adding opportunities. As a result, the company needs to seek ways to inspire value-creation and to encourage an entrepreneurial spirit and mind set throughout the organization. Strategic flexibility is also an important consideration in designing the partnership agreement. A long-term relationship commonly results from a successful joint venture. To strengthen the partnership relationship and enable longevity, BP's actions should encourage:
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cooperative interaction to promote active problem solving, trustworthy behavior, knowledge sharing, and consistent pursuit of ways to combine resources and capabilities to create value, full awareness and disclosure to reduce the harmful effects of opportunistic partner behavior, the frequent use of open channels of communication, and higher levels of trust (and an awareness that trust is affected by the initial condition of the relationship, the negotiation process to arrive at an agreement, on-going partner interactions, and external events).
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Increased trust lowers monitoring costs. To build social capital and more influence with shareholders, BP should avoid pursuing legal action against AAR for violating the shareholder agreement and should not actively resist Russian shareholder interests. SUMMARY Given the current landscape, there are troubling risks associated with doing business in Russia. The suggestions proposed above are aimed at reducing those risks and taking advantage of the interdependence among all stakeholders for mutual gain. To further improve conditions, top executives within the organization need to make more of their own political connections, build better relationships at the Kremlin, and work to be a trusted ally of key players in the industry and the state. Representatives of the company need to acknowledge and respect that Russia is trying to protect its vital national energyproducing activities. It would also help to confirm that Russian authorities support any new agreement arranged with AAR or any other partners. Additionally, the company should absolutely use its connections within the British government to take forward issues which benefit trade between the two nations. It is in BP's best interest to leverage all of the political connections which can be developed.
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